Monday, October 6, 2008

How to choose a mutual fund lazily and hazily

Didn't they teach you at school that you shouldn't be lazy ? Anyway, it's your decision to be lazy and, entirely your decision to invest in a mutual fund, but if you want to do both together, then you are not alone and you have come to the right blog.

This is the 2nd part of a 3-part guide to investing in Indian Mutual funds. The other parts are linked from here.

Time period of investment :

Unlike bank deposits, you don't "contract" a mutual fund investment for a particular pre-defined period. (Except in cases where there is a lock-in period like 3 years). You put money whenever you want, this is called "buying a certain number of units in a mutual fund scheme". You can take your money out whenever you want. That is called "Redemption of units" or "Selling of units of a mutual fund scheme". Usually speaking, the longer you stay invested in a scheme, the better it would be for you. (That is, assuming, the scheme is doing reasonably well than its peers). Because the main returns potential of equity lies in the long term.

The Million Dollar Question:
Is my money safe, will I atleast get back the principal ?

No, It's gone forever to charity. Jus kidding. :) :) Yes, it's pretty safe, as safe as it can get these days in these parts of the universe. There is an element of risk on how a scheme will perform and there is this usual disclaimer of "past performance not indicative of future returns, consult the offer document and don't consult a blog before investing". But there is nothing phoney or hush-hush about it, nor is there guarantee promises of sky-high returns. But if you are an average-risk-taking youngster with an eye on long-term, reasonable wealth creation, then it's meant for you. Also, no one will deny the money due to you except in case of national financial calamities (Just threw that word, I don't even know what it is). At the least, whatever is the current market value of your investment will be given to you. Of course, the basic assumption is that everything is dependent on the stock markets and more specifically, on the stocks that your scheme has bought. The market value of your fund on any given day, is derived from the market value of the stocks that it has invested in. Heheheh, the stock market is itself dependent on a million parameters, including the flap of a butterfly in Timbuktu. :) It's not much different, for example, from investing in gold or in real estate as an investment option.

How to choose a mutual fund :

There are many ways ranging from a lot of work to a lazy click. Since laziness is relative and changes behaviour according to the observer, It's better I'll explain what I usually do at my level of laziness. I like to keep choices simple, without going into detailed statistical analysis. And as far as possible, I want to keep it "impersonal", that is I would rather look at data than fall for someone's marketing speech. If a distributor tries to talk me into a new fund offering, why do I get that faint suspicion :) :) that he has no clue how the scheme is going to perform and his eye is on the 6% commission. How so mean of me! Aren't they humans too and don't they have families to support ?

I usually go to Value Research Online, they have rated the funds as 5-star, 4-star, 3-star and so on. Have a look at the 5-star or 4-star funds. In fact, keep looking at it from time to time, to spot and register names in memory over a period of time. I usually go in only for the equity funds. So I just pick one of them and invest. And try to pick a different fund house or a different scheme every time. Of course, this is anything but time-tested, since I am pretty young in the investing arena, just 3 years. And this is put right in the middle, because it applies to the whole article. This is not professional financial advice and if by any stroke of imagination, you thought it is, then you need professional counselling, psychiatric. If you haven't read the save-skin disclaimer, you haven't read anything at all. :) :) And hello, I am in no way connected to the owners of any of the links, except for the fact that we all share the same vast, wide, internet.

But, you don't have to go by that one site. There are other sites, which my friends find useful. Like PersonalFn , MyIris and I am also a fan of CRISIL's Quarterly ranking of mutual funds. Rediff Money , Yahoo Finance India and LiveMint also seem to do a good job in data presentation and tutorials on the various aspects but they do a simple ranking based purely on returns. The one good thing that attracted me to ValueResearch and CRISIL, is that their rating is based on risk-adjusted return, means, they prick the returns generated with the risk it has taken and then rank them. You should also know that such a rating methodology might itself be a subject of criticism. There is also this Association of Mutual Funds website, more of an official kind.

Net Asset Value :
It shows the value of your money on a given day. It's declared every day for most schemes. If you had bought some scheme for Rs.200 per unit, last year same day and it's net asset value today is Rs.230 then your investment has grown at 15% p.a. This calculation applies only for the Growth Option, we'll skip other options for later.

What's about this Growth option or Dividend option :

There are three options when you are buying any scheme. In dividend option, the you get dividends on your investment, from time to time, as and when dividends are declared. Growth option, is somewhat like a Cumulative Interest Fixed Deposit, when you choose to sell, you get your "grown-up-value" of your investment. There is a third option called "Reinvest Dividends", that means, dividends will be declared, but for that amount, units of the same scheme will automatically be bought at that day's rate. Usually, dividends suit elders who are dependent on periodic income. Youngsters are better off with the Growth option.

Can anyone invest in mutual funds ? What will I need ?

If you want to invest more than Rs.50000 in a single go, you need a PAN. In fact, even otherwise, you are better off having a PAN, because I think they might make it mandatory for a lot of other things shortly, like sneezing in front of a bank :) or marrying a banker. You would also need to mention your bank account number and probably attach a copy of a cancelled blank cheque leaf bearing your account number. When you sell, they'll give you a cheque for the proceeds and you will be allowed to deposit that cheque only in this bank account. Of course, in the meanwhile, if you change your bank, you can intimate them.

Investments above Rs.50000 also require you to get something called a "KYC Clearance for Mutual Funds". (Know Your Client). It's a one-time thing like PAN and it's pretty simple procedure.

Every scheme has a minimum investment amount. Most equity funds require you to invest a minimum of Rs.5000/-. Some funds also have something called an Exit Load (something like handling charges for exit). Means, if your units are worth Rs.5000 and the exit load is 1% , you get only units worth Rs.4950/-

You won't need a proof of address. For investments below Rs.50000/- Id proof is not required. (Please note that this rule may change after this web page is published)

What range of returns can one expect ?

God knows. But if you want some information from lesser beings, some of the best diversified equity funds fetched between 13-18% p.a. if you look at the last 3 years and between 30-35% if you look at the last five years. Obviously, I have a way of presenting whichever data is presentable and giving a limited picture of the unlimited chaos. Also, depending on where you stand, this might be the wrong time or the right time to look at how the market has performed. As someone put it, the sensex is back to where it all began, at 13000. You should have seen my face when it touched 21000. Anyway, look at data for the last 5 years, impersonally, here.

No, you want to quit, without reading Part 3. Because you may not emerge with your wallet intact. Thats okay, looking at that much data makes me dizzy too, but, by now you must have realized, the whole point of this guide is the wry humour and poor jokes that are embedded here and there.

Look for those in Part 3, that explains : How to buy and how to sell.

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THANK YOU: These reflections draw sometimes from readers and friends who initiate ideas, build up discussions, post comments and mention interesting links, some online and some over a cup of coffee or during a riverside walk. Thank you.

Disclaimer: Views expressed in this blog are the blogger's personal opinions and made in his individual capacity, sometimes have a story-type approach, mixing facts with imagination and should not be construed as arising from a professional position or a counselling intention.