The Mutual Fund Show: Understanding The Basics Of Investing
The first step while choosing a mutual fund scheme...
When it comes to saving or investing money, most Indians would opt for fixed deposits or gold as they offer stable returns. But professional management, liquidity and diversification, among others, make mutual funds a good alternative to such traditional methods, and they provide superior returns over the long term.
The first step to invest in mutual fund schemes is to build a portfolio. While doing so, investors need to understand their goals and evaluate risk appetite. There, however, are a couple of warnings that are issued—mutual fund investments are subject to market risks and past performance doesn’t guarantee future returns.
As some may find the process cumbersome, BloombergQuint spoke with two financial advisers for a step-by-step guide about investing in the first of a four-part series on the weekly special The Mutual Fund Show.
The most important part is to understand investment goals and preferences. “Goals should be SMART—Specific, Measurable, Achievable, Realistic and Time-Bound,” said Amit Bivalkar, managing director and chief executive officer at Sapient Wealth Advisors & Brokers Pvt. Having a well-defined investment goal, he said, can help avoid making mistakes that investors otherwise will.
Tarun Birani, founder and director at TBNG Capital Advisors Pvt., agreed. “The average equity return in the last 20 years is about 12% but when you look at average investor return in the same period then it is 6-7%. The reason for that gap is nothing but investor behaviour as they exited the market when they should’ve actually invested because they did not have clearly defined goal in place,” he said.
Having laid down a clear goal, Bivalkar said investors must evaluate their risk tolerance and accordingly decide their exposure into equities and debt. “If you have a long-term investment horizon, then it is advisable to have a higher exposure towards equities.”
While Bivalkar suggested a 60-40% equity-debt allocation for a first-time investor, Birani advised a 50-50 allocation with one very good equity fund with a long-term history and a mix of debt funds in the portfolio. “With experience and a better product understanding, investors can gradually scale up their equity exposure,” Birani said.
And finally, Bivalkar advised investors to not chase past returns.
Watch the full show here:
Here are the edited excerpts from the interview:
What is it that you would do as a first step when you decide to invest in a mutual fund?
Bivalkar: What I feel is that you should be good at what you do. So if I’m a good chef, I should be good at cooking and I should not manage the tables. If I’m good at managing technology, then I should be working in an IT company and not managing my portfolio. But if you want to invest, I think you need to have a professional manager who needs to handle your investments and for that, along with the diversification, liquidity, transparency, put all the points together, then the answer is only mutual funds.
If you want your money to be professionally managed which will be transparent, they will print fact sheets every month and will have liquidity, you can invest as low as 500, all of this put together in a tax-efficient structure with pooling of money, I think that is mutual funds.
Tarun, what are the first few things that you would do, the very basics?
Birani: There are a lot of ways to reach a destination — you can drive your own car, or you can hire a chauffeur for yourself, or you can take public transport. In my opinion, mutual fund is nothing but a public transport. Chauffeur-driven, according to me, the definition is a portfolio management service. If you can drive your car yourself, then it is self-investing, which is a very difficult thing to do in today’s time because everybody has a job to do and it requires a regular commitment. Because when you manage your own money you get very emotional about it. So, I also agree to what Amit has said that this requires hand-holding, this requires some bit of counseling on a regular level to reach your goals. Mutual fund is nothing but a way to reach your financial goals, according to me. Since there is a benefit of diversification and transparency, all this put together, it helps you achieve your goals.
Amit, what are the things that you would keep in mind when you choose a mutual fund? Would you think of the geographical diversification that you have in your portfolio, or say, what kind of percentage do you want in equity versus what percentage you want in debt?
Bivalkar: First, what my risk profile is. I need to identify how much risk can I tolerate. And after I do my risk-profiling based on some questionnaire which the adviser gives me, I will be in a position to ascertain that okay I can be 40% in equities and 60% in debt, or 70% equities and 30% debt.
- Identify your risk
- Write down your goals as to what money I will require in how much time period—if you require money below five years, I think you should not look at equity but go only with debt. If you require money after five years for your long-term goals, then clearly you should go in for equity.
- Where should I invest? Most of the times here is where a mistake is made. I look at last year’s, last month’s or last week’s returns and probably try to chase those returns. Remember, if you want to invest for long term, it doesn’t matter whether you invest today or tomorrow. If you have that 10, 15, 20-year horizon, I think then you will make your money. Don’t go and chase past returns. Look at a fund which has got pedigree, true value, which has its fund objective pretty clear, and which actually shows you a consistent performance rather than a patchy performance.
Tarun, what percentage ideally would be equity versus debt, and I know that one size doesn’t fit all, but still try and generalise. Two, what kind of risk profile should people have when they are trying to invest in mutual funds, and three, does geographical diversification play an important role in deciding how to go about investing in mutual funds?
Birani: You rightly said one size fitting all is not a solution. Everybody has a very unique risk tolerance capability. Risk tolerance as a subject relates to what has been your past, what is your future, where do you currently stand at—there are a lot of factors that goes behind. I had a client who is 35 years old but his risk profile is very low. Though he has a long-term outlook towards his investment but his appetite to take risk is very low. So according to me, that is the first part where a lot of time needs to be spent and you require a doctor to actually check your right risk appetite. For that, a detailed suitability analysis needs to be done for each and every client and each and every family member to my mind.
Let’s assume that an investor will not be able to go to a financial adviser. So, now let’s approach this with that subject.
Birani: First you need to figure the basic risk profile and how much loss or drawdown you are ready to take. Let’s say, if I am not able to take a 30% fall, let’s say in a 2008 market where we have seen a 30-40% drawdown in the market, how would have I reacted at that point of time? Would I have sold all my mutual funds at that point of time? I have seen a lot of clients reacting like that. That is the first test of risk tolerance. If the answer to that is the client will continue investing, he is a passive investor. To start with that, will take him to a 70-30 kind of respect, and on that basis he can build up a portfolio.
Another important factor is the age. A client at age 30-35 definitely will have a much better risk-taking capability compared to somebody who is at a retired stage.
Third and most important part is goals. Let’s say from a goal point of view, if the client requires the money five or 10 years down the line, I think that he could take a much bigger risk compared to somebody who is on a lower scale.
On geographical diversification, according to me, you don’t get everything in India. From a quality point and governance point of view, you don’t get the best of the companies that are available. And now with the LRS kind of scheme available, as well as the global mutual funds available to us in India, I feel global diversification is a very important thing, and at least 10-15% of the portfolio globally should be looked at. There are U.S. funds available, Europe, Japan, China, etc. My strong suggestion would be to look at global diversification.
Amit, do you want to add something to this?
Bivalkar: Indians have a habit of leapfrog. I mean, we have never used laptops and directly went to iPads. What happens is, have I understood or ever fully invested in India is my first question? The primary basic thing is have I invested in equity? We are 1.5% of the nation’s population in terms of folios in equity mutual funds. Basic investment is common sense—if I know that I order a pizza from a particular brand, if I know that there is metro work going in my city, if I know that I like a particular brand of car and I see more of them on the road. So, you actually need to buy things which you see around, and all of that as a package you can get in an equity mutual fund. For any layman investor to come to a mutual fund, the first thing is like watering a plant. Don’t try to look at NAVs on a daily basis, whether the fund NAV has grown and whether I have made more money as of yesterday. Why do we say that real estate makes more money in the long term because we keep that real estate for 30-40 years and we do not look at prices of real estate on a daily basis. While in an equity fund, we try to find out the NAV if there is a fall in the market or there is a rise in the market. First and foremost is, if we want to probably look at becoming wealthy, then we should actually keep money for 10, 20, 30 years. Don’t be hasty. There are simple things like lump-sum investing. Even if you had Rs 1 lakh and you are getting a 12% return, then in 10 years you actually have Rs 3,10,000. If you look at 20 years, you have got Rs 9,60,000. Similarly, with SIPs. Everybody is talking about SIPs after you’ve seen the market correct in March and April, but if you just continue your SIP at Rs 10,000 a month with an assumed return of 10% or 12%, in 25 years that Rs 10,000 per month makes you Rs 1,89,80,000. You don’t need to be a part of Kaun Banega Crorepati where you want to have that Rs 1 crore with you.
There are only three things that you should have — patience, perseverance and discipline. And if you have that with you and will stay invested for long, I don’t think you need any other product or need to go and buy direct equities as well because after all, everything returns to normal. So, just keep on investing every month.
When the market falls, add more money but your vision has to be for 10, 15, 20 years. You will not look at your insurance policy for 15 years, you will not look at the NAV also even if it’s a Ulip, then why so in case of mutual funds?
Tarun, because diversified asset classes can give you different returns, people who are invested in land, gold and bonds should consider adding equity mutual funds or mutual funds as an investment class as well?
Birani: There are various kinds of asset classes available and primarily there are four kinds — equity, debt, real estate and commodities. In commodities you can add gold. So if you look at returns from a long-term point of view, from a wealth-creation objective—the annualised returns of Sensex over a 40-year period has been close to 17% versus gold, which can give you inflation-linked returns. With these returns in mind, I feel you need to have a portfolio with a mix of all... If we have a long-term outlook, I feel equity as an asset class will be the biggest wealth creation asset class. As Albert Einstein has also said compounding is the eighth wonder of the world, and to get this compounding magic, you need a mix of assets. And asset allocation is the most important thing, it’s an art, it’s not a science, according to me. It requires your behaviour to be managed correctly and for that behaviour, you need to act very unemotional, you need to be much disciplined and, according to me, the magic lies there.
Amit, do you want to make an additional point to this?
Bivalkar: If you look at the Forbes richest list worldwide or in India, you will never find a land estate baron listed there. You will never find rajas or maharajas, you will never find Sachin Tendulkar or a sportsman in that list but you will always find a Jeff Bezos, Bill Gates and Warren Buffett who are either owners of businesses or invest in shares of other companies. So, clearly, over long term, equity is the only thing which makes you money.
What percentage of a person’s portfolio do you recommend to somebody who’s coming for the first time? Let’s assume the person is of an average age, has average income and average risk profile.
Bivalkar: So, I will probably look at a 60-40 equity-debt allocation with a combination of small or mid-cap funds, along with multi-caps. And in debt, I will probably give him bond funds. I’m looking at maybe a combined yield at about 9% with a 60% equity and 40% debt combination, and he should be sticking his money for the next 10-15 years. I think at 9% compounding, he will make a lot of money.
Birani: My suggestion would be to start with a 50-50 kind of an allocation. With a 50-50 mix, one can take a mix of one very good long-term history equity fund and a mix of debt fund in the portfolio. That would be a great start and maybe one year with this experience and the client understanding this product better, I think equity allocation can be increased further.
Tarun, how important is a goal when you’re investing through funds?
Birani: I think this is not only relevant to investment, but also in part of our life. Anywhere where there is no purpose behind it, I think that thing never happens in life. Anywhere you look at like our education, we have a goal and purpose. That’s where we started. I wanted to move into commerce that’s why I selected accounts or all these streams for myself. Without a goal and purpose, I don’t think you can achieve anything. I speak at many forums and whenever I’ve asked people that who all want to get rich, everybody says I want to. But when I ask how many have made their financial goals, 5-10% people have a financial goal in mind. So, that is the problem. You want to get rich but you don’t have goals in mind. One needs to very clearly define goals. Let’s say for my retirement with my current standard of living, I look at Rs 1 lakh as my monthly expenses. So if I want to stop working, what is the minimum amount I need to have in mind? This brings a lot of motivation in terms of savings.
Since the last 20 years, average returns equity or Sensex has given is 12% but when we look at average investor return that is less than 6-7%. The reason for that 4-5% gap in returns is nothing but the behaviour. People have behaved opposite to what they should have. They exited when they should’ve actually invested in the market. It is because they were not investing because of the goals but because some friend or family told them to.
My strong suggestion is if you want to get this 12% return, you need to have a clear cut long-term goal in mind that you are investing this for your children’s future or retirement. Once you start with that, I think things will be much more easy for you to stay disciplined.
Amit, do you advise your clients to have a goal?
Bivalkar: I think the goal should be SMART. S stands for specific, M stands for measurable, A stands for achievable, R stands for realistic and T stands for timeliness. So, your goal should be ‘smart’ wherein it should be a specific, maybe retirement or education. It should be measurable—you should monetise the value of the future goal and you should have a target. It should be achievable—it should not be something that you can’t really reach. It should be realistic as well. The last one, it should be time-bound. So when you have ‘smart ‘goals, I think the journey becomes very easy and that is the way we should plan our goals.
Amit, anything that you want to speak about this chart (all the advantages of investing through mutual funds)?
Bivalkar: I think it’s something like you have got everything in one and that’s too good to be true. That’s why I think people don’t invest in mutual funds on a big scale because they feel that if everything is in one product, then there must be some problem with that product. Believe me you, I have been in the industry for 22 years and if you keep the discipline and if you actually keep on investing for the long term, you don’t need anybody, you don’t need a good in-laws house which is wealthy and rich but you only need your discipline patience and perseverance and you will actually be in the Forbes top list one day.
Tarun, 30 seconds on this chart?
Birani: According to me, three things stand out for mutual funds. One, professional management, which I think we ourselves cannot do, it’s a full-time job. Second, transparency. I have seen a lot of fake brokerages taking away money and such things. You need a very transparent structure. Mutual funds give you that. And diversification. I think buying stocks yourself is a very difficult thing. Mutual funds again give you a lot through diversification.