Mutual Funds: Seven Mutual Fund myths that can mislead you

Mutual fund investors generally become the victims of common myths pertaining to mutual funds as an investment product. These myths either emerge from an inadequate understanding of the mutual fund product or the way the product is marketed by the mutual funds themselves. It is, however, necessary to overcome these 7 myths as they are critical in helping you make an informed and intelligent decision about your mutual funds. Here are the 7 myths you need to overcome before investing in mutual funds…

Topics Covered

• I go by mutual fund ratings
• If I can do an SIP in mutual funds, I can do an SIP in stocks too
• Like in case of stocks, I will buy mutual funds that have corrected sharply
• Mutual funds give an assured return on my investments
• Funds that offer a higher return should be preferred
• A mutual fund investment has no proof of ownership or title
• Floating Rate Funds
• Monthly Income Plans (MIPs)

1. I go by mutual fund ratings

This is a major myth. Remember, a mutual fund rating is based on the past performance of the fund. The past performance need not be repeated in future. Secondly, the mutual fund may have had a strategy that may have worked specifically in that period. That does not mean that its strategy will work in changed circumstances. As a mutual fund investor you need to do your homework. Look at their past performance, look at their portfolio mix and try to understand what the fund manager is saying through his monthly notes. The MF ratings can be a starting point for your MF investment decision, but it cannot be a substitute for your investment decision.

2. If I can do an SIP in mutual funds, I can do an SIP in stocks too

Of course, you can always do an SIP in stocks too. But remember that when you do SIP in stocks, you run the risk of direct investments in stock markets. So you need to track the stocks, track the news and other announcements as well as industry trends. When you invest in mutual funds, your fund manager takes the trouble of creating a strong portfolio for you and you also get the benefit of diversification. So equity SIP can be an alternative for your lumpsum investment in equities. It cannot be an alternative to a SIP in mutual funds.

3. Like in case of stocks, I will buy mutual funds that have corrected sharply

Again you are wrong in both the cases. Whether it is stocks or mutual funds, a sharp correction cannot be the only criterion for buying them. A sharp correction in NAV can be due to a variety of reasons. The fund may be facing redemption pressure. Alternatively, it may be exposed to the wrong industry or theme. For example, tech funds that were launched in 2000 saw their NAV deplete by 80% in 1 year. That did not automatically make them a buying opportunity.
 
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4. Mutual funds give an assured return on my investments

That is a big myth. Mutual funds do not assure you any returns on the funds. In fact, SEBI explicitly prohibits mutual funds from ensuring any kind of returns to fund holders. Whether you invest in a debt fund, index fund or an equity fund, there is an element of systematic and unsystematic risk involved. As a fund manager, he can only manage these risks better and improve on asset selection. We have seen how assured return schemes have faltered in the past. There is nothing like assured returns in mutual funds.

5. Funds that offer a higher return should be preferred

This is again a dangerous line of thinking. A fund may be giving a higher return purely because it is taking higher risk. A fund that generates 15% return with 20% volatility is surely better than a fund that generates 20% return with 60% volatility. Greater the volatility, greater the chances of the fund earning negative returns. Don’t judge a fund by returns. There is an important risk aspect to it. Always look at returns adjusted for risk. That is a better benchmark to measure and compare funds.

6. A mutual fund investment has no proof of ownership or title

Well, you are right in one way that you do not get any title documents. For example when you purchase an apartment there is a sale deed. Similarly, when you buy equities, you either get physical shares or a demat credit. When you buy a bond, you get a bond deed with the stamp of the issuer. That is because a mutual fund holding is not an identifiable asset unlike the above. A mutual fund statement is proof enough of your holdings. You need not worry because mutual funds are regulated by SEBI and have to adhere to strict compliance requirements. Of course, if you do insist, you can ask for your MF units to be held in demat account like equities.

7. You can never create wealth through an SIP

To begin with, wealth is a relative term and hard to define. But to understand the value of a SIP, you need to understand the power of compounding. Let us understand this with the help of an example. If you start a monthly SIP of Rs 5,000 for a 10 year period and expect to earn 12%, you will have a total corpus of Rs 11.5 lakh at the end of 10 years. If you earn 16% instead of 12% in the above example, your corpus at the end of 10 years increases to Rs 14.6 lakh. If you do an SIP of Rs 10,000 instead of Rs 5,000/- you will end up with Rs 29.3 lakh at the end of 10 years.

Recommended Read: How mutual funds can address your liquidity goals?

8. Monthly Income Plans (MIPs)

The real clarity will come when you extend the time horizon to 20 years. If you do Rs 5,000/- SIP for 20 years at 12% annual return you end up with Rs 49.5 lakh corpus at the end of 20 years. If you assume 16% annual return then you will end up with a corpus of Rs 86.3 lakh. Had you done an SIP of Rs 10,000/- instead of Rs 5,000, you will end up with a corpus of Rs 1.72 crore at the end of 20 years. This is how the importance of mutual funds is compounding has a geometric effect on your wealth creation over longer periods of time.
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