3 myths about mutual funds

Ask any prolific investor in company stocks/shares why he does not take to mutual funds with the same ardour and enthusiasm, and the reply you are likely to get is that mutual funds are dull and boring. He is also likely to say that mutual funds lack the thrill that one gets by investing in stocks.

1) Mutual funds lack excitement

Who wants to invest in a staid investment like a mutual fund that probably grows half as fast as some 'exciting' stocks like Infosys, Satyam or Dr Reddy's during a bull run? The poser is relevant.

Underperformance almost always gets the thumbs down, no matter what the reason. After all, every investor wants his money to work for him and if a stock does that better, why invest in a mutual fund?

Mutual funds may lack the excitement of a stock, but it is the kind of excitement that investors can do without. If an Infosys posts 19.0% net profit growth as it did in March 2003 (FY03) and still crashes 40% over the next two days; how many investors want to live with that kind of 'excitement'?

And remember Infosys is not a Himachal Futuristic; it's a solid stock with solid fundamentals. Mutual funds may not scorch the investor's portfolio in a bull run like some 'exciting' stocks, but you can be sure they won't burn a huge crater in the investor's portfolio either, when individual stocks are crashing by 40%, for instance.

2) Mutual funds are too diversified

Mutual funds own too many stocks to be of any serious benefit to anyone. A focused portfolio of 8-10 stocks will generate a more attractive return than a mutual fund portfolio of 30-40 stocks.

We are not sure if there is any theory to prove or disprove that concentrated portfolios (8-10 stocks) do better than diversified portfolios (30-40 stocks in the Indian context). Of course, investment guru Warren Buffet has successfully managed a small portfolio

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But not too many investors can claim to have his investment discipline, insight and experience. In the absence of these important traits, it would be a delusion to expect a concentrated portfolio to outperform a diversified portfolio, at least not over the long-term (3-5 years).

Remember fund managers are experienced money managers and their mandate is to outperform the benchmark index of the fund. And if they have chosen to go diversified, that tells you a little about how to go about making money in the stock markets.

3) Mutual funds are too expensive

Mutual funds aren't cheap. On an average, the recurring expenses for a diversified equity fund ranges from 2.25% to 2.50% of net assets. Add to this a one-time entry load of about 2.25% (for most diversified equity funds) and you will understand why mutual funds are more expensive vis-à-vis investing directly in stocks.

The 2.50% (maximum) recurring expenses charged by the mutual fund go towards meeting the brokerage costs, custodial costs and the fund manager's salary. These are expenses that stock investors incur in any case (except for the fund manager's salary).

Consider this: when you have a competent fund manager, who combines his time, effort and expertise to research stocks and sectors to pick his best 30-40 stocks and also buys and sells them for you, you have someone who is doing a lot of work for you and is charging only a maximum of 2.50% of your investments.

Of course, we agree that this must be followed by sheer outperformance of the benchmark index and even peers, as you don't want to pay for underperformance.

The good news is that quite a few diversified equity funds have managed to put in what can be termed as 'a very good performance' over 3-5 years vis-à-vis the benchmark index and peers.

Investing is serious business that is best approached with a methodical approach. Mutual funds allow for that and investors must try to benefit from them.

At the end of the day, being a successful investor is all about making the most prudent investment decisions, even if they are dull and boring.

3 myths about mutual funds

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