Are you still not investing in mutual funds due to misconceptions: Part 2

We discussed in the first part of this series, how mutual funds are getting popular due to the increasing awareness. The investors are slowly but surely realising that mutual funds are best and probably the only way for wealth creation and meeting their different life goals. However, a huge population of our country still hesitate to invest due to many myths and misconceptions surrounding mutual fund investments.

In this second and concluding part of this series, we will try to bust some more myths. Please read on...

Demat Account necessary for investing in Mutual Funds

This is another common myth. While Demat Account is mandatory for investing in equity shares, there is no such rule that it is also mandatory for investing in mutual funds. In fact mutual fund is one product which can be invested in both ways – through demat account and also in physical mode (that is, without demat account).

Those investors who buy mutual funds through their stock broker can buy and hold mutual fund units in electronic form in their demat accounts. However, the most common way is investing through physical way. In this case, you get an account statement from the AMC and you can redeem or buy further units by approaching your financial advisor or the AMC. The process is very simple – all it takes is your signature on the transaction or application form and the cheque, if you are investing additional amount.

In fact, these days transacting online has become very popular. Here, even though you are transacting electronically, you do not need any demat account. Moreover, units bought online can be redeemed off-line by submitting transaction slip and so on.

Therefore, if you want to start investing in mutual funds there is no need to have a demat account.

Latest top performing funds are better

When some funds are performing well it becomes very popular courtesy media, Asset management Companies and advisors. Everyone starts pushing these schemes which results in more sales. The recent top performance funds get headlines and appear on top of mutual fund research websites which prompts the investor to go with these funds.

Investors should note that investing in mutual funds should be based on ones risk taking ability and the time horizon. For example – a sectoral fund or midcap fund might start performing great due to some changes in the sector but the same may not continue in the future.

Therefore, investors should not chase or invest in these unless it suits their risk profile and also matches with their investment horizon. Investors should always consider funds with long term performance track record, the ability and record of the fund manager in generating alpha for the investors and of course the Asset Management Company.

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Investing in a number of funds means more profit or diversification

Since there is a tendency to invest in popular or latest top performing mutual funds, investors accumulate many funds over a period of time. This is a big concern and hindrance in not getting the desired returns on your mutual fund investment.

As we mentioned earlier, fund selection should be strictly on the basis of risk profile and time horizon. If you know these two, then you should prepare your asset allocation and set financial goals and return expectations. Now that you are done with these two, that you should select few funds with a proven track record and invest.

Investing in few proven funds can do wonders to your portfolio than holding many funds without knowing their pedigree or track record. Also, more funds do not mean more diversification or more return. Investing in a few good diversified equity funds with proven track record is the best way to look for diversification and getting the expected returns.

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Investors must book profits periodically

There is no hard and fast rule that profits should be booked by the investors when a certain amount of returns have been generated. This is a dangerous myth as sometimes investors book profits from the funds that are performing well and wait for the returns to come from the funds that are not performing well.

This myth erodes the potential returns that you would have got had you remain invested in your top performing mutual funds which you had redeemed. The point to be noted here is that as you remain invested for the long run you benefit by compounding.

The other point is that you should not hold on to the underperforming schemes with a hope that the returns will come in future. In fact, these are the schemes which should be redeemed first when you are reviewing your mutual fund portfolio.

As investor you should hold on to the top performers in the portfolio till such time your investment goals are met.

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MFs with higher rankings by third party agencies make the best buy

As an investor it is wise to explore various websites see the top performing mutual funds, talk to your financial advisor and then take an investment call. However, we have found that there is a tendency amongst the investors to invest in funds with high rating and expert reviews by so called experts.

The problem in selecting funds this way is that while fund rating from a good rating agency might be okay but having said that the rating or reviews does not assure that the desired returns will follow in future. Moreover, each agency follow its own methodology in rating funds and there is no full proof method which can clearly rate funds.

Then what is the way to select funds? There are many actually.

The common way should be to compare the scheme rating across various websites and see if it is same across agencies and then read the Scheme information document and check the investment objectives of the scheme and if it is aligned to your investment objectives. You should also talk to your financial advisor in seek his help in this regard.

As an investor, selecting schemes solely based on high ratings by research companies and reviews on television channels and other electronic media can be detrimental to your mutual fund portfolio health.

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Returns from Mutual Funds are taxable

There is a tendency amongst investors to consider products which give higher or fixed returns. What are mostly not considered are the tax benefits or the post tax returns that the product might or might not offer?

As far as mutual funds are concerned, investors have vague idea about its taxation and therefore the myth that mutual funds are not tax efficient and so on.

We feel that while considering investments the tax implications along with the potential returns should be the best way to decide. If someone is looking for tax efficient and post tax higher returns then mutual fund is the only product which fulfils both the criteria.

While ELSS schemes provide tax rebate under section 80C of the Income Tax act 1961, the returns from equity mutual funds are tax free under long term capital gains. The dividends received from mutual funds are also tax free.

Not only that, debt mutual funds provide better post tax returns than other fixed income products as indexation is allowed in case the holding period is more than 3 years.

For investors looking for regular returns from their equity investments, SWP withdrawals are also tax free after one year from the date of investment in case of equity funds.

In a nutshell, every category of Mutual Fund has a different taxation angle and investors should be fully aware about these while investing in the same. Investing more tax efficient way enhances your overall return and therefore it should be an important criteria.

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Conclusion

Over years many stories about mutual funds have been passed around and investors have started to believe those as facts. The authenticities of the facts or arguments must be checked before investing and blind acceptances should be avoided. The only way to bust the myths is educating yourself about mutual fund investing with hardcore knowledge and facts, not opinions and ideas or myths.

Myths get perpetrated because there is no way to question or authenticate the validity of the facts that are being presented. It is simply because lot of investors may not have the knowledge to counter the arguments that are being made. Therefore, we feel that taking help from a mutual advisor to start your mutual fund investing journey is the right way.