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Mint money with mutual funds
Larissa Fernand |
November 11, 2004
here is a common saying among traders: Bulls make money, bears make money, pigs get slaughtered.
And you definitely don't want to be slaughtered.
But you have to admit there's no investment as enticing as shares.
Here's an example.
Let's say that on a sunny day in May 1995, you bought some shares. Nine years down the road (May 2004), you sold them.
*Infosys and *Wipro were your first picks. You would have paid Rs 530 and Rs 405 per share respectively. When sold, they would have fetched you Rs 5,399 and Rs 1,648.
That means you earned an impressive annual compounded return (that is, whatever you get in return for your investment is reinvested; you don't encash it) of 29 percent and 16.85 percent.
You might say this is a lopsided example. If you had bought *TISCO shares in 1995 and sold them in 2004, you would have paid Rs 227 and got just Rs 368.4 in return. That's a mere 5.5 percent profit.
What if you had bought shares of *Videocon Appliances? You would have dished out Rs 92 and got just Rs 15.15. Disgraceful!
As far as the share market is concerned, that is where the catch lies. The greater the possibility of a high return, the greater the risk of losing it.
How do you get those impressive returns while lowering the risk of dabbling in the stock market?
Just because the risk is high and you find the idea of buying shares intimidating, it does not mean you should turn your back to the stock market. All you need to do is give the matter a little more thought and make your decisions wisely.
This is where a mutual fund enters the picture.
A mutual fund hires trained analysts who select and manage shares for you. You get the return you want; and the risk you face in investing in the stock market lowers.
In a mutual fund, individuals ('investors' in professional parlance), give their money to professionals (known as fund managers), and pay them a fee to invest their money for them. The fund managers invest and manage this collective money (known as portfolio) to get the best possible return at the lowest possible risk.
The benefits are tremendous.
~ Start with small amounts
If you have a small amount -- say Rs 5,000 -- you may not be able to buy the shares of the company you want. Infosys, for instance, will be out of your reach.
Even if you can afford it, you may just be able to buy a share or two.
Rs 5,000 could get you three Wipro shares or 13 TISCO shares.
You could also consider investing this money in a mutual fund. Even if the fund's units (units are like shares of a mutual fund; while companies offer shares, mutual funds offer units), are being sold for Rs 50 each, you will get 100 units.
You could also opt for a Systematic Investment Plan. This means you invest a certain amount in the mutual fund every month instead of investing it at one shot. You can start with as little as Rs 500.
~ You don't need specialised knowledge
You don't have to analyse the stock market or the companies in which you are interested when you invest in a mutual fund
Every mutual fund has a specialised team of investment analysts. Their sole function is to analyse the stock market and the performance of the companies. Based on their analysis, they decide which companies the mutual fund will invest in.
These analysts get reports from external researchers. They meet the senior management and employees in various companies as well as their vendors, customers and competitors in order to understand the business.
They also take the industry (in which the company functions), and the overall economy into account before deciding whether to invest, and how much to invest, in the company.
~ You don't need to constantly check on your mutual fund units
Let's assume you are investing directly in the stock market.
You would have bought, say, a *TISCO share at Rs 227 in 1995.
If you had waited to buy it when the market fell in 2001, you would have paid just Rs 82.
Also, if you had purchased a *Videocon share for Rs 92, you would have seen its value reduce every month.
If you had sold it after a year, you would have sold it for Rs 45.
But you waited until May 2004 when your share price dropped to just Rs 15.15. If you had sold your shares in 1996 instead of 2004, you would have minimised your loss.
Unlike most individuals, the fund manager does not decide what makes a good buy and then sit tight.
His team continues to monitor the investment to see if it is time to sell, if the company is no longer capable of achieving expected results or if better opportunities exist in other companies.
When to 'go heavy' (buy more) on a particular stock or sector and when to 'offload' (sell) are decisions that can be taken when one monitors the stock market, the company and the industry closely.
At certain times, the fund manager may just decide to hold a major portion of the portfolio in cash because of lack of good investment opportunities.
~ The risk reduces
Consider this: You bought Videocon shares in 1995. You would have suffered a severe loss (and probably a heart attack, if you had put in all your money into it).
But if you had also invested in Wipro and Infosys, it would reduced or negated the loss you suffered because of Videocon.
A mutual fund spreads your money (and the money of other investors who have invested in the same scheme), among different companies and different industries. It increases your chances of making a profit. Should one company go down the drain or one sector fare badly, you will not be the loser -- because the other companies and industries your fund manager has invested in are performing well.
The knowledge that you need to do this -- not to mention the time, money and effort -- needed for this kind of 'diversification' (spreading money across different industries and companies), is beyond most of us.
Investing in a mutual fund means you lower your risk even as you benefit from the rising stock market.
~ Profit, anyone?
If you don't think mutual funds make profits, consider this.
The Alliance Equity Growth fund has given a return of 46.82 percent over three years, while the Franklin India Bluechip (Growth) fund has given a return of 45.64 percent over the same period.
This means if you had invested Rs 100 each in each of these mutual funds, you would have got back Rs 316 and Rs 308 respectively.
Shares are the only investment that have consistently beaten inflation over the long term. It is a risky investment option but it also gives the highest return.
It would not be fair if I did not warn you about the risks in investing in a mutual fund.
The main drawback: If you invest in a fund where the manager knows as little about the stock market as you, you will not make a pie. Worse, you could lose what you put in.
Remember: Every mutual fund charges an 'entry' and/ or 'exit load'. This means a small percentage of the money you invest remains with them as their fee.
But this is not really a drawback. After all, you wouldn't expect anyone to do this for free, do you?
So, despite your fear of the stock market, do consider investing at least some amount of your savings in the stock market. And what better, or more convenient, way to do it than a mutual fund?
*The highest share price for the months of May 1995 and May 2004 are taken for all the stocks mentioned.
NEXT WEEK: How to select the right mutual fund
Image: Dominic Xavier