My mom is a better investor than Mr X," is what a friend commented the other day. Mr X happens to be the Chief Investment Officer of a reputed mutual fund.

And in what way was her mother better? 

Apparently, my friend's dad had given her and her mother some money and told them to invest it. My friend bought the units of a mutual fund (the one whose fund manager she was criticising) while her mother invested in some shares.

Her mother ended up with a higher return than she did. Hence the conclusion.

What my friend fails to realise is that in this bull run, everyone's mother would have made money. So this one-time fortunate investment in a stock does not make her a savvy investor, despite what the family thinks.

The essence of a good investor is one who not only knows how to ride a bull market but also a bear one.

I wonder by how much her fund units would fall in value when (and if) the stock market crashed. And when that happens, I would also like to see the value of her mother's investment.

What's scary is that individuals who have never set foot in the stock market want to suddenly dive in. I'm not suggesting that you ignore the stock market. All I am saying is that you should probably not enter directly if you not sure of your footing.

• 6 large-cap equity funds to consider

How to make a crore in the market

If you want to make money in the market, a good avenue to explore is a diversified equity mutual fund.

Value Research studied a few diversified equity funds that existed since 1995. Their returns were looked at from July 1995 to June 2005.

Let's say you invested Rs 20,000 every month in a mutual fund during this time frame. This is what your investment would have been worth at the end of the period. 

Franklin India Prima	Rs 1.77 crore
HDFC [Get Quote] Equity	Rs 1.51 crore
Franklin India Bluechip	Rs 1.36 crore
Franklin India Prima Plus	Rs 1.26 crore
Birla Advantage	Rs 1.01 crore
HDFC Capital Builder	Rs 96.9 lakh
Prudential ICICI [Get Quote] Power	Rs 93.2 lakh
Tata Growth	Rs 89.3 lakh
Magnum Global	Rs 88.3 lakh
Canexpo	Rs 80.2 lakh

Rs 1 crore = Rs 10 million
Rs 10 lakh = Rs 1 million

That means an investment of Rs 24 lakh (Rs 2.4 million) over 10 years (Rs 20,000 every month over 10 years) would have given you the above return.

• How to build a mutual fund portfolio

The trick to making money

Let's take the same time period: July 1995 to June 2005

Let's say you put in a fixed amount every month in a mutual fund. The amount does not matter since we are looking at returns in percentage. You would have made an average of 20.37% per annum. This periodic investment in a mutual fund is referred to as a Systematic Investment Plan.

But, if you just invested once in July 1995, the return would only 13.41% as against 20.37% mentioned above.

Here are the annual returns (given in percentage) over the various years from some consistent performers, had you invested in an SIP.

8 year return as on June 30, 2003
9 year return as on June 30, 2004
10 year return as on June 30, 2005

• How risky is your mutual fund?

So how do you pick a winner?

All funds will not give you great returns. There will be winners and losers.

1. Compare funds with the benchmark

A fund's benchmark is an index that is chosen by a fund company to serve as a standard for its returns. The market watchdog, the Securities and Exchange Board of India, has made it mandatory for funds to declare a benchmark index.

In effect, the fund is saying that the benchmark's returns are its target and a fund should be deemed to have done well if it manages to beat the benchmark.

Let's say the fund is a diversified equity fund that has benchmarked itself against the Sensex. So the returns of this fund will be compared vis-a-viz the Sensex.

Now if the stock market is doing fabulously well and the Sensex keeps climbing upwards steadily, then anything less than fabulous returns from the fund would actually be a disappointment.

If the Sensex rises by 10% over two months and the fund's Net Asset Value rises by 12%, it is said to have outperformed its benchmark. If the NAV rose by just 8%, it is said to have underperformed the benchmark.

But if the Sensex drops by 10% over a period of two months and during that time, the fund's NAV drops by only 6%, then the fund is said to have outperformed the benchmark. The key is not to look at the fund's performance only during a bull run but also during a bearish phase.

If in the midst of a bull run, a fund has delivered great returns, a check must be made with its benchmark. If the fund shows negative benchmark returns, this indicates that their performance is just a side-effect of the markets' rise rather than some brilliant work by the fund manager.

2. Compare funds with their peers

How has the fund fared when compared with the rest in the same category?

Here you have to make sure that the time period and the type of fund is identical. For instance, you cannot compare the one-year return of a fund with the five-year return of another.

Moreover, don't compare a diversified equity fund with a sector fund. Compare it with another diversified equity fund.

So a fund may have delivered positive returns and even outperformed its benchmark. But, if its peers have gone way ahead in terms of returns, then it's time you took a good look at the fund. 

• Balanced funds to consider

Making money

The key to making money in the stock market is entering via a mutual fund and using the SIP route. This allows you to invest fixed amounts every month. So when the Net Asset Value is high, you will get fewer units and when it is low, you will get more units. Over time it evens out and you can safely ride the ups and downs of the market.

Don't try to time the market. You could lose all your money.