Mutual Funds: Five MF Myths That May Mislead You
Mutual funds have emerged as an effective financial instrument to build up a corpus for different financial goals such as raising children, getting married, buying a house or one’s own retirement. From the types of funds, from the investment horizon to the returns that can be expected, it is useful to separate the myths from the facts before investing in mutual funds. Here are some relevant myths dispelled for better investment decisions.
Myth: Equity funds will provide consistent returns every year
Reality: Mutual fund returns are not guaranteed and are linked to market movements in the underlying securities. Nevertheless, an assumption of an annualized return of 12% to 15% over the long term is made when referring to the growth rate of equity funds. However, this does not mean that 12% growth will occur every year.
In fact, stocks are volatile in nature, so they can generate both negative and positive returns over a period of time. Returns could be as high as 50% in one year, but the next year returns could be as low as 7% or even negative. Still in the long term, several studies carried out in the past have shown that equities drift upwards and it is to the compound annualized growth rate, that is to say to an average return, that we are referring.
Myth: All mutual funds invest in stocks
Fact: One can invest in different asset classes such as stocks, debt, gold, real estate through mutual funds. Depending on one’s risk profile, goals and requirements, one can build an asset allocation plan by investing in mutual funds and not necessarily equity. Ideally, equity funds help during the accumulation phase, while loan funds help preserve accumulated capital as goals approach.
Myth: Solution-focused funds are adept at achieving goals
Reality: There are specific mutual fund plans that focus on solutions for saving for goals such as a child’s education or retirement. These systems, typically, have lock-up periods and invest in both stocks and debt securities in varying proportions. In fact, opting for large- and mid-cap plans may prove more advantageous than directing investments towards solution-focused funds, which are less flexible and have lower potential for high returns.
Myth: A lower NAV is better than a high NAV
Reality: If you invest in a mutual fund with a lower net asset value thinking it’s a better “deal” than buying a fund with a higher net asset value, think again! Let’s say you invest 10,000 rupees each in Scheme A (an NFO with a net asset value of 10 rupees) and Scheme B (an existing scheme with a net asset value of 20 rupees). By doing so, you hold 1,000 units of Scheme A and 500 units of Scheme B. Now, assuming that both schemes have invested their entire corpus in a single stock, which is currently listed at Rs 100, let us examine the value of the fund s there is an appreciation of NAV. If this stock appreciates by 10%, the net asset value of the two schemes will also increase by 10%, to Rs 11 and 22, respectively. In both cases, the value of your investment increases to Rs 11,000, an identical gain of 10%.
Myth: Mutual funds only serve long-term goals
Reality: You can use mutual funds to achieve your short, medium and long term goals. For goals that must be achieved within three years, there are short-term funds, liquid funds, and several other debt funds where you can park funds for a shorter duration. Similarly, hybrid funds with exposure to both equities and debt are useful for medium-term goals. For objectives of at least seven years, opt for equity funds. Depending on your needs, time horizon and risk appetite, you can choose any type of mutual fund.
FACTS VS MYTHS
There are MF programs for various asset classes such as stocks, debt, gold, real estate
Large-cap and mid-cap plans can offer better returns than solution-focused plans
You can use mutual funds to achieve all your short, medium and long term goals
Mutual fund returns are linked to the market movements of the underlying securities