More units in an MF doesn't always mean more money

As the stock market has gone up, so has the frequency with which mutual funds have launched new schemes. It is easier to sell new mutual fund schemes to investors when the markets are doing well in comparison to when the markets are not doing well.

A lot of investors get out of their existing mutual fund schemes to invest in new mutual fund schemes that come along. The primary sales pitch such investors fall for is 'You will get more units.'

But having more units doesn't really make a difference and it can even work against the investor.

Let us see how this sales pitch works. Say, an investor has 511.5 units of a scheme whose current net asset value (NAV) is Rs 20. So the total value of his investment is Rs 10,230 (Rs 511.5 x 20). A mutual fund distributor approaches this investor and asks him to invest in a new scheme whose new fund offer is currently on.

So the investor sells out of the existing scheme and gets Rs 10,230, which he invests in the new scheme. In a new scheme, units are issued at a price of Rs 10. Other than this there is an entry load of 2.25% for the retail investor. 2.25% of Rs 10,230 works out to Rs 230, and this is paid as the entry load.

The remaining Rs 10,000 (Rs 10,230 - Rs 230) actually gets invested. Against this Rs 10,000 the investor gets 1,000 units. So, as we see, the number of units nearly doubles and the investor is really happy about it.

But what difference does it make?

Let us say the scheme the investor originally was in and the scheme the investor is in now, make the investment in the same set of stocks. One year down the line, these stocks give a return of 25%. So the NAV of the original scheme has gone up to Rs 25 (Rs 20 + 25% of Rs 20). The total value of his investment in this case is Rs 12,787.5 (Rs 25 x 511.5 units).

In case of the new scheme the NAV of the scheme after one year is Rs 12.5 (Rs 10 + 25% of Rs 10). The total value of the 1000 units the investor has in this case is Rs 12,500 (Rs 12.5 x 1000 units). So even though the schemes have performed equally well in both the cases, the investor loses out by moving onto a new scheme because he pays an entry load and hence a lesser amount of money gets invested.

Hence, he would have been better off had he stayed invested in the old scheme.

What really matters at the end of the day is the stocks the fund manager invests in and not the number of units an investor owns.

Given this, it always makes more sense investing in schemes which have a certain track record in the market and not in any new scheme that comes along.

Now comes the bigger question of why do mutual fund distributors make this selling proposition, even though it is not in the best interest of the investor. The answer lies in the fact that no broker has ever made money by letting his investors stay on to their investments.

Similarly, a mutual fund distributor makes a trail commission of around 1%, if the investor continues to stay invested in the scheme. On the other hand if the investor invests in a new scheme the distributor is likely to make 2-4% of the amount invested as commission.

It is simple economics which is at work here. Also an investor has a limited amount of money to invest. Every time a new scheme comes along, an investor need not have more money to invest in it.

So the simplest way out for a distributor is to get an investor out of an existing scheme and get him to invest in a new scheme.

Earning big bucks won’t make you wealthy. Know why

You are reading this because you want to be wealthy. How does one become wealthy? By earning/making lots of money, right? WRONG. Famous Australian financial advisor Noel Whittaker said, “Becoming wealthy is not a matter of how much you earn, who your parents are, or what you do.... it is a matter of managing your money properly.”

There is dramatic difference between making lots of money and managing (keeping) lots of money. Making money and managing money requires completely separate set of skills. For making money we need knowledge and expertise in our area of occupation. A good CEO is one who is well qualified and experienced in his job. A good singer has trained his/her voice and also performed several times. A successful businessman understands his trade well.

Nowhere in above examples will we find that to perform well in one’s occupation money managing skills are required. There are completely separate sets of skills required for managing money. Unfortunately there is no correlation between skills required for making money and skills required for managing money. If there was co-relation between two skills then we would have never had instances of businessman who have ‘made’ lots of money going bankrupt. Bankruptcy is cause of poor money management. Similarly, we know of several instances where actors/sportsman of yesteryears who earned lots of wealth in their hay days but struggled in their later years of life.

First thing you ought to know to become wealthy is the knowledge of amount of money you have. Do you know your exact bank balance? How do you keep track of your bank balance? Do you use net banking, ATM center, tele-banking, do you refer to bank passbook/statement or do you, on your own know how much money you have in account. If you are dependent on any of the bank’s channels like net banking, ATM, tele-banking or their statements for knowing your balance then it means that your bank is telling you how much money you have in them. Ideally shouldn’t it be you who should be telling bank how much money you have with them? In case you are finding it difficult to remember bank balance start maintaining parallel bank passbook but always ensure that it should be you who should be telling bank how much money you have with them and not vice versa.

Exactly same principal applies to your spending and more so in case of credit cards. If you are depending on your credit card statements to find out your spending, someday or the other you will face problems. Always save your charge slips. Better still if you can maintain a register to track your spending.

Over a period of time develop habit of maintaining all your records. File your investment statements, income-tax papers, insurance and pension policies, property documents, WIIL etc.

Lastly keep reviewing. Wealth management is not one off exercise. Many a times individuals feel money management exercise is difficult and cumbersome, but then who said that money management is easy.

3,500-year-old investment tips that still work!

. Pay yourself first

When we think of budgeting against our income, we typically look at our expenses: how much do I have to pay my landlord, my grocery bills, my medical expenses, my entertainment bills, et cetera. Once we have decided on our expenses, we find out what our savings will be.

Financial advisors and many credit card companies (or banks) today help clients in estimating their lifestyle expenses and help them understand where their money is being spent.

The old book turns this theory on its head: it says 'pay yourself first.' Before you pay others for the services that they give you, you should save money for yourself. You are working for yourself and not just for paying your bills and, hence, you should receive a fair share of your income for yourself.

The Richest Man of Babylon decrees that you should pay a minimum of 10% of whatever you earn to yourself. And the best thing is: once you have paid yourself, you will realise that your lifestyle does not change at all!

In today's consumption-driven world, this simple philosophy takes a back seat. It is important to nip the temptation of over-spending at the bud. With facilities like ECS available today, it is easy to transfer money to investments as soon as income is received.

For the clients that we have done that, they say that after the first couple of months, they have become used to the lesser disposable income, and do not feel the pinch in their life style at all.

2. Make your money work harder

The Richest Man of Babylon says that the only way for your money to grow is if it procreates. Using a wonderful analogy, it states that the money saved -- and invested -- is the father and it should bear children. The joy -- and the secret to financial independence -- lies in seeing the children grow bigger than the father.

It is very instructive to learn the difference between savings and investments. Indians typically 'save' a lot -- as demonstrated by the savings to GDP ratio of around 30%. However, in many cases, savings do not translate into investments, which earn returns.

Leaving money in the savings account for a rainy day is not investment. Such savings are like impotent people, who are progressively eaten away by age -- and inflation.

With the development of the financial markets, there are many avenues in which savings can be easily invested to procreate. Depending on your circumstances and requirements, you can invest in equities, real estate, long-tenor fixed deposits, etc. The idea should be that the children (the interest or dividend or capital appreciation) is so large that they can support their original father -- you.

Once your passive income is enough to sustain you, you are out of the rat race.

3. Take calculated risks -- but do take them

It is not always that the best intentions produce the best results. After having saved for one year as decreed by The Richest Man in the book, his disciple gave all his money to a merchant who was to go into far seas in search of the spices. Neither the boat, nor the man returned and all the savings of the disciple were lost.

While it is important -- rather it is a prerequisite -- that you need to take some risks to earn returns on your savings, you need to be careful in evaluating the risks that you can/should take. The first thing that you need to understand is the amount of risk that you are able and willing to take. It is easy to confuse between the ability and willingness -- and this is where you will need the assistance of your financial advisor.

Depending on your circumstances, you should define the amount and nature of risks that you can take. If you are nearing your retirement and have painstakingly built your nest-egg over your working life, it is important for you to ensure safety of your principal.

Conversely, if you are young and without responsibilities, you can risk your savings for higher returns.

4. Be persistent

After losing the money with the sea merchant, the disciple wanted to give up on saving and investment, saying that it is an illusory game leading to losses and pain. The Richest Man warned him not to lose heart and to continue the process year after year throughout his life. When the disciple invested -- more cautiously -- the second time, he not only received his principal back, but also received handsome interest.

It is easy to be lost in the maze of headlines and advisors who talk about the uncertainties in the markets and their abilities to time and make more money out of it. While one can try to get that extra return by tactically optimising on the portfolio allocations, what should not be lost sight of is that the mantra to investment success is to be disciplined.

There will be shocks on the way, but it is important that your savings are working for you.

It is surprising how the logic of wealth-creation written down millennia ago is still relevant today. The British archeologist who found these stone tablets was in a debt crisis, with credit card companies knocking at his door daily. By following the simple dictates above, he not only made his life debt-free, but set out on a path to financial independence!

Sensex hits 15K – How to get the best from MFs now

Sensex touched a new all time high today. The stock market has had a remarkable run since touching its low of 8900 in June 2006. Needless to say, the last one-year or so has been quite eventful for investors in equity funds. If one were to analyze the behavior of investors during different phases of the stock market, there are lessons to be learnt for existing investors as well as for those who intend to make equity funds an integral part of their portfolio.

Market Ups & Downs

Every time the market goes up, many investors start wondering whether this is the right time to exit. In fact, there are investors who make the mistake of exiting too soon. It is important to remember that equities are a long-term investment vehicle and one needs to give one’s money enough time in the market to get the best results. Remember, if one takes a wrong decision, there is always a risk of missing out on good rallies in the market or getting out too early thus missing out on potential gains.

• Is it time to say Goodbye to your fund?

Similarly, whenever the market turns volatile, it causes anxiety and in some cases, even sleepless nights. In times like these many investors abandon a carefully designed investment strategy as a knee jerk reaction and pay the price for it. Obviously, it is not be a smart thing to do. The key is to recognize that volatility exists in the market place and will remain so. After all, volatility is a statistical measure of the tendency of the markets to rise and fall. While volatility can be described as a natural phenomenon, there is a need for investors to develop ways to deal with it.

Invest Regularly

Though a lot has been written about systematic investing, it is often perceived as an option only for small investors. The fact of the matter is that systematic investing has nothing to do with the size of the investment. It is a way of disciplined investing that allows investors to invest in the stock market at different levels without having to worry about the market levels and the market movements in the short-term. Remember. When you opt for regular investing, you abandon any strategy that might control timing of your investments. In other words, you continue to invest irrespective of market conditions. This strategy works very well partly because of “averaging” and partly because in the long run markets move upwards, in spite of short-term falls.

• 7 good reasons to invest in SIPs

It is not to say that one should not invest a lump sum amount in equity funds. For a long-term investors, making a lump sum investment is not an issue, however, a lump sum investment should not be the end of the story. Instead, it should be taken as a beginning of an investment programme to build wealth over time and needs to be followed by regular investments as and when investible surplus is available. Either which way, the key to successful equity investing is making investments on a regular basis.

5 corners of a sound Investing Strategy

The market is a roller coaster and let know one tell you otherwise. In the short term the market outlook may seem uncertain. But on the longer horizon Indian markets look very good. The government has been making conscious business friendly policies; the fiscal deficit too is getting under control. India continues to be one of the fastest growing economies in the world. These factors coupled with many others are ensuring India’s position as a global investment destination. To grow personal capital from India’s growth one has to choose the correct investment avenue.

Choosing between the plentiful available mutual funds and schemes is not easy. A well thought out and well-planned decision is one that will bear fruits in the long run. Thus a structured approach to fund selection with a systematic checklist to achieve it is of utmost importance. Even though there are many available methods of product comparisons, one doesn’t want to be weighed down by all of them. Dwelling into too many numbers, will only lead to further confusion. Therefore only a few areas of comparison are of true importance and will be comprehensive enough to produce a thorough comparison.

Portfolio
Portfolio is very important while comparing schemes. Even though some of the underlying stocks in portfolios could be similar, most portfolios have differing mandates and investment philosophies. As a result it is rather important to understand the stance the manager has taken while building his scheme portfolio. The portfolio will not only determine the future outcome of your investment but will also tell you how risky the product is and hence if it is appropriate for your appetite. For example, an equity scheme, which invests in large cap companies, could be safer than one that invests in mid or small cap companies. The portfolio for debt instruments is determined on duration of securities. A high duration, high return investment is potentially volatile and risky; while a short duration investment Portfolio is less risky. This is where we come to the next parameter of comparison - Risk.

Risk
In today’s scenario, investments that generate meaningful post tax; post inflation returns have risks attached to them. These are market risk, credit risk, government policy risk etc. At this point one has to understand how much risk he is willing to take in order to generate higher return. The rule of thumb is that the more risk one is willing to take the better the returns potential. The measurement for risk to return is known as Sharpe Ratio. The higher the value, the better the risk attached to the scheme is managed. A volatile investment can also be very risky. Thus this aspect must also be quantified. Standard deviation will help us understand the volatility of a scheme vis-à-vis its benchmark. Be aware a riskier investment is not always better and a sure fire way to generate superior returns. (Check out - Why hybrid funds are best hedge against risks?)

Performance comparisons
These are the most favored methods of investors and amongst the easiest. Performance numbers are available in plentiful. But performance is only measured in hindsight, and can never be guaranteed in the future. Also performance can only be compared across similar categories of funds. For example, performance or return comparison between an equity scheme and a debt scheme should never be done. It must be kept in mind that comparison happens only between similar funds. A large cap fund should be compared with another large cap fund and not a mid cap fund. Thus compare apples to apples only. Performance and return comparison should be conducted usually when one has decided on the above-mentioned factors like risk and product category. (Read more - Don’t just look at ‘Returns’, look at quality too)

Fund management and Institutional backing
Since trusting your hard earned savings to some one can never be easy, it is important to evaluate their money managing capabilities. The markets are a game of understanding numbers and involve immense skill to generate growth from these numbers. Only a very capable person with a lot of experience can generate capital appreciation in today’s confusing market swings while managing risk.

Investment horizon
It is very important to determine investments based on one’s time horizon viz equity typically being volatile should be considered for investment horizon of 1 to 3 years. While the short term debt schemes should be considered for investment horizons of up to 1 year. (Also read - 4 reasons why debt funds are smart buys)

It is therefore important to invest with a fund house with a good track record. It is also important to give due weightage to the quality and track record of the spouses of the fund. After evaluating these parameters and choosing a scheme one can be reasonable sure that the investment they are going into is the right one. At this point I would like to stress, that any of these parameters could only be a guiding star and not a guarantee for the future. Choosing an investment avenue is like getting into a marriage, so do it wisely