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Common Misconceptions about Mutual Funds Investing

Feb 29, 2016 by Priyanka Chakrabarty | 96 Downloaded
Picture courtesy - PICJUMBO

What stops us from doing what we wish to? It is not the lack of money or time. It is simply fear. We do not want to let go of all that we have accumulated in order to embrace something that may lead to losses. This fear is the reason we have never carried out half our wishes. How does this fear break? There is no better weapon to fight fear than knowledge. You read so much about the concerned subject that you can counter any fear or objection that might be raised.

The same fear is still deep rooted in Indian mindsets when it comes to investing. We are very hesitant to move ahead of Bank savings and recurring deposits or maybe postal savings. People are extremely afraid of investing in anything that has the word ‘equity’ attached to it. Why are investors so afraid? There are too many stories of loss and risk attached to equities or mutual funds and stock markets while there has never been a story of loss or inefficient returns in Fixed Deposits or Recurring deposits. Hence, investments in Bank deposits or postal savings create immense security.

Over the years many stories have been passed around and people have started to believe those as facts. The authenticities of the facts or arguments have been questioned and blind acceptances have created the factually incorrect facts or myths. The myths have been perpetuated long enough for investors to be at a loss to believe what exactly is the truth. The only way to bust the myths is educating investors with hardcore knowledge and facts, not opinions and ideas.

Today, in this article, we will try to bust a few myths to help you get a clearer idea of what you may be losing out when you ignore investing in Mutual Funds due to some common misconceptions.

Myth #1: Mutual Funds Invest only in Stock Markets

Myth Busted

The truth is just opposite of this myth. Mutual Funds have been designed in such a manner that you do not just have to rely on stock markets to be able to invest in equities. ‘Equity Mutual Fund's is that category of Mutual Funds that invest in Equities of various companies or sectors or has equity linked components allowing investors exposure to equities. However, investors who may not be comfortable with a high degree of equity exposure can opt for schemes which have Equity, Debt or fixed money market instruments or exposure in gold or real estates.

Diversified Equity Funds, Balanced Funds, Debt Funds and Sectoral Funds are examples of such mixed exposure.

If investors want to do away with the Equity component altogether, then they also have the option of Debt Mutual Funds where investments are made in Bonds, Securities and short and long term money market instruments. All asset classes are incorporated in various schemes of Mutual Funds allowing investors with varying degrees of risk appetite, investment horizon and investment needs to choose a fund appropriate for them.

Myth #2: Mutual Funds are only for Long term Investors

Myth Busted

The fundamentals that govern Mutual Funds are compounding and ‘Time Value of Money’. These two concepts set Mutual Funds apart from other investment options. It has been observed that the longer an investor stays invested it helps in growing the corpus. The time invested matters more than the amount invested. However, there is no hard and fast rule that investors who do not stay invested for longer period of time get nothing out of their investments.

There are mutual Fund schemes created exclusively for the benefit of short term investors. Investors who wish to stay invested for a period of one to three months can go for Liquid funds. Investors who have an investment horizon of less than a year can go for ultra short term debt funds. If an investor wishes to stay invested for one to three years they can either opt for income funds or Fixed Maturity Plans where returns are generated within a given time period. Hence, irrespective of your time frame, you will find Mutual Fund products catering to your investment needs.

Myth #3: Mutual Fund Investors need a Demat Account

Myth Busted

To start investing in Mutual Funds you need a Bank account, PAN Card and fulfil KYC formalities when investing for the first time. The requirement is as basic as that of opening Demat account used by investors who wish to trade in stocks and shares. To invest in Mutual Funds investors have to go through a onetime process of filling up a Know Your Customer or KYC Form. This is a onetime process which needs to be carried out while investing for the first time. After that investors can keep investing across all AMCs and funds without filling any additional identity or address documents.

However, investors who have a Demat account and wish to keep the mutual fund units in electronic form may do so. Not only that, they may even buy and sell mutual fund units using their stock broker’s trading platform.

Therefore, we can conclude that Demat Account is not mandatory for investing in mutual funds.

Myth #4: Systematic Investment Plan is meant for Small Investors

Myth Busted

Systematic Investment Planning or SIP investing has been created to inculcate the habit of investing among the masses. It is to encourage people who have never invested to start investing. It is also to debunk the common myth; you need to have a lot of money to be able to make a lot of money. The reason a lot of investor invest through SIPs is to beat market volatility. Instead of investing a big sum in one go and exposing the entire amount to market ups and downs, you invest small amounts in regular frequency. It allows investor to get the best of rupee cost averaging while riding the market volatility.

There is no limit to the amount an investor can invest every month. They can invest as less as 500 every month to as much as any amount per month or per week or per quarter. It does not matter how much you earn to wish to invest through SIPs rather it makes the process of investing simple allowing all to make the best of their money with little amount of risk.

Myth #5: Higher Number of Mutual Fund Schemes means Lesser Risk

Myth Busted

Having too many Mutual Fund Schemes in your portfolio does not necessarily reduce the risk. It is the type of Mutual Funds that matter more than the number of schemes. The factor that mitigates risk is how diversified your portfolio is. Suppose you have invested in five different banking sector Funds and you believe that you have mitigated risk because the investment is spread out in five funds. When the banking sector takes a hit all your investments are going to suffer equally.

You can easily manage this fall by not investing in 5 banking sector funds but by spreading your investments in different category of funds such as Diversified Equity Funds, Balanced Funds, Debt Funds or Liquid Funds and maybe a small portion into a Sectoral Fund. You may have had to invest in only three to four funds but your portfolio would have been diversified. A good portfolio will have a few schemes of varying nature and that is what helps in mitigating risk through diversified selection.

Myth #6: Mutual Funds with the Highest Returns are the Best Funds

Myth Busted

One of the most erroneous ways of judging a mutual fund is assessing its past performance and expecting that the performance is going to be constant in the years to come. The best funds are not those who generated high returns historically. One of the landmarks of a good fund is consistency. If a fund has been generating consistent returns over the years despite market conditions, then that might be worth staying invested with over a long period of time. However, you should consider checking Rolling Returns of a Mutual Fund Scheme or Top Quartile Ranking of the funds with the help of a financial advisor.

In bull markets a lot of funds perform exceptionally well and their performances drop when the markets are bearish. It is sign of an inconsistent fund and not a well managed fund. The fund manager may have been taking unnecessary risks to take advantage of the bull market and that’s why fared badly in the bear markets. Any fund that has huge inconsistencies in their returns is volatile in nature and does not make a great investment. The consistent performers have been known to be the highest return generators over a long period of time.

Myth #7: All Returns from Mutual Funds are Taxable

Myth Busted

Every category of Mutual Fund has a different taxation angle and they are not uniform. Equity Linked Savings Scheme or ELSS is a scheme that qualifies for tax deduction of up to 1.5 Lacs per annum under section 80c of Income Tax Act 1961. While it allows investors to save taxes, the long term capital gains tax and the dividends received are also tax free.

Similarly, Equity Mutual Funds are also exempted from long term capital gain taxation if an investor stays invested for more than a year. The dividends received from Equity Mutual Funds, Arbitrage Fund, ELSS and Hybrid Equity Oriented Mutual Funds are also tax free. Dividends received from Debt Funds are also tax free. However, Long term capital gains (Holding period of 3 years or more) are taxed at 20% after allowing indexation benefit. Therefore, Debt Funds also enjoys lower taxation compared to fixed deposits.

Myth #8: Mutual Fund Investments must be Timed

Myth Busted

Investors for some strange reason are obsessed with timing the market. The hard truth is you cannot time the markets. Investors tend to be optimistic when the markets are bullish and pessimistic when the markets are bearish. It is the typical investor's behaviour which leads to higher investment during bull markets. If you are investing in Mutual Funds, any time to invest is a good time. Markets works on a cyclical movement of ups and downs. However, if you wish to stay invested for a long term the short term fluctuations will cease to matter. Mutual Fund returns rely heavily on the investment horizon. Instead of trying to time the market, if you just invest, the time period will add significantly to your investments.

Conclusion

Myths get perpetrated because there is no one who questions their authenticity or validity of the facts that are being presented. This is because a lot of investors may not have the knowledge to counter the arguments that are being made. To be able to slowly counter these deep rooted myths investors need to start questioning the already existing ideas and opinions. Once this happens the pathway to investing will be a much smoother one. If you still have some more misconceptions do write to us at advisorkhoj@gmail.com or contact a Mutual Fund Advisor in your locality.

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Priyanka Chakrabarty

A literature enthusiast who loves to write. An ardent social worker who dreams of bringing about change and hopes to do so through her writing. A firm believer of the saying pen is mightier than the sword, Priyanka is an English Honours graduate. She also pursed Diploma in Wealth Management Practice from IIFP and is a certified social media expert.

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