Revisiting the purpose of investing in mutual funds

What was the original purpose of MFs?

Quite simple, actually.

Mutual Funds started as a cost-efficient way for a small retail investors to take exposure to stocks with a diversified portfolio. This diversified portfolio can be actively managed or passively based on a stock market index.

Investing in equity is a great way to build wealth. You can do it by investing in direct stocks, however, it needs time, effort, knowledge, skill, money and lot of control on the mind.

The next best option is the mutual fund.

Let’s revisit the basics of mutual funds here –

1. It is a vehicle for a small, retail investor who cannot go onto invest resources to build his/her own stock portfolio. A mutual fund can do that for you.
2. Building a decent size portfolio requires a sizeable chunk of money. Take for example, investing in the 30 stocks of BSE Sensex. It would need a few lakhs to buy 1 share of each of the companies. With a mutual fund, you can take an exposure to diversified portfolio with as little as Rs. 500.
3. You can choose an actively managed fund where a fund manager uses his/her own research to determine the set of stocks. Alternatively, you can just buy an index fund where the fund management costs are NIL. You only pay for the costs of indexing.
4. You don’t have to worry about each stock in the portfolio, only about whether your fund sticks to its mandate and is providing a reasonable return at a reasonable cost.
5. The costs are not very high. A typical fund charges you less than 2%, in fact closer to 1% with direct plans, of the market value of your investment every year. The costs are lower for index funds.
6. You can easily enter or exit a mutual fund. There is enough liquidity at almost all times.

Mutual funds are tools of patience. You should not expect single stock like growth with funds. Since they work with several stocks, with mutual funds, expect a gradual growth over long periods of time.

Here are some points to keep in mind when investing in mutual funds

• Don’t move in or move out of your mutual funds a lot. Don’t change your funds every month.
• Shortlist your funds after a thorough study and then invest. Don’t get influenced by performance alone. Rather focus on the mandate of the fund and has the fund been following it.
• You don’t need more than half a dozen mutual funds to build your portfolio. You don’t have to invest in every fund and its every variant out there. You only end up spreading your portfolio too thin with none of them having the power to make a difference to your portfolio.
• Choose the growth option so that the compounding can work better.
• SIP is a convenience and not a mutual fund’s name.

So, why are you investing in mutual funds? Let me know in the comments below.