Creating wealth through mutual funds.

It doesn’t matter whether you are an aggressive or a conservative investor. Mutual funds help create wealth for your long- and mid-term goals.

T he general perception is that if one had more money at one’s disposal, one would have a better plan to use it properly. However, the reality is if you have a better plan, you would make more money. Most of us believe that it is necessary to secure our and our family’s future, but what prevents us from doing this is the lack of funds. This is where most of us go wrong and miss the earlybird advantage. However, with the right planning and approach, you too can achieve your financial goals with whatever little you mange to save. Mutual funds (MFs) provide a safe and easy option in creating wealth. Here is a step-by-step guide to help you create wealth through MFs.

Why Mutual Funds

 An MF is a financial product that pools money from different individuals and invests it on their behalf into various assets, such as equity, debt or gold. Based on one’s financial goal or risk appetite, there are several MF schemes to choose from. Some of the key features of MFs are simplicity, affordability, professional management, diversification and liquidity. MFs give investors the flexibility to invest in the various asset classes. Also, unlike several other financial products, MFs give you the freedom of not having to invest on a continuous basis. You can stop your investment in an MF scheme when there is no cash flow. That said, your invested amount will have the potential to grow till you decide to liquidate it.

Low cost of acquisition of high quality assets

One of the biggest benefit of MF investments is that you don’t need to be a financial expert. The investment decision is taken by investment experts, such as fund managers, who help you manage your money professionally.

 In lieu for their services, sector regulator Semi has allowed them to charge a small percentage of the entire corpus money that they manage in the MF scheme, making MFs very cost-efficient. These, together with the flexibility to invest in either a lump sum or in small amounts, makes MFs one of the best instruments to create wealth over the long term. As mentioned earlier, the flexibility to invest in various asset classes and the freedom from having to invest on a continuous basis, do not affect your cash reserves drastically and your invested money has a growth potential that you could depend on. Therefore, MFs are an excellent tool for creating wealth over the long term.

The First step Budgeting. Budgeting will help you keep your purse strings tight. This effectively translates into savings that you can invest for your long term financial goals, such as home buying, children’s education and your own retirement. Budgeting helps you to cut down your bills, such as telephone, grocery and the like. This will also help you in reducing the frequent expenditure on outings, movies and dinning at restaurants. In effect, you will be able to put a fix on your regular expenses 3 Creating Wealth with Mutual Funds every month and the amount you can save (where you to cut down on certain expenses) and channelize the same into your investments.

 Savings and investments. Merely saving will not help you create wealth, unless you invest it into financial instruments that can generate inflation beating returns. Also, the earlier you start investing, the more wealth you can create. An early beginning in all walks of life is a good recipe for success and the same holds true for investing. Early birds have an advantage over those who are off the blocks late. They manage to save a decent pile for all their requirements with fewer hassles. The essence is to invest early and remain invested for long, so that your money gets the maximum time to grow to the required levels and at the required time.

Power of compounding

Power of compounding gives you the edge—the more time your money gets to grow, the more you gain. If you start saving early, even in small amounts, it will help you build a sizeable corpus. The rule is to invest regularly and keep investing the returns.

As a result, your earnings will also participate in getting more returns. For example: X starts investing `2,500 per month at 25 years, while Y, who is of the same age as X starts investing `5,000 per month ten years later. When both X and Y turn 45, X would have amassed a sizeable corpus of `22.78 lakh, while Y will have only half as much (`11.09 lakh), i.e., on a 12 per cent return, despite Y investing more than X. An early start to investing in equity MF schemes also inculcates discipline as you invest regularly.

Stock markets remain volatile on the short-to medium term, but average-out over the longer horizon. An investor, who remains invested over the long term even during the ups and downs of the stock market, is largely unaffected. And, most importantly, mistakes made during the initial day’s helps one learn the basics of investing, which in turn, helps you become a mature investor.

Regular savings: SIP Way

A systematic investment plan (SIP) allows an investor to invest a specific amount in an MF scheme of his or her choice over a certain period. While SIPs are available for all MF schemes, they are most effective in equity schemes, as they are a more volatile asset class than debt. SIPs help in regular savings as well as in riding on the volatility of the equity market.

An ideal way to profit from stock market volatility is to buy units when it is trading low and sell them when it is at a high. But that’s easier said than done. It is here that SIPs come in handy. They help an investor buy more units when prices are falling and fewer units when prices are rising. When the net asset value (NAV) of an MF scheme falls because of a stock market crash, you accumulate more units at lower rates, while in a rising stock market you are allotted fewer units. Over long periods, SIPs help lower the average purchase price of units.

At most times, your average unit cost will always be below your average sale price per unit, irrespective of whether the stock market is rising or falling. Only in extremely bearish phases will an SIP investor book a loss. Technically, SIPs keep the average purchase price of units down, without having you to second-guess the stock market situation.

Besides, the investment in installments (since an SIP investment involves investing a fixed amount at regular intervals into an MF scheme), help you achieve a higher return from equities than other investment methods. SIPs are most-effective over long periods of time—the investor profits from the appreciation equities tends to show over the long term.

Make your wealth grow with equity MFs

Schemes that invest in equity shares of companies are called equity MF schemes. As an asset class, equities have the potential of providing high returns with an acceptable levels of risk, but the challenge lies in understanding the behavior of equity markets over a long period of time— not a year or three, but at least over a decade or more.

One must begin investing in equity through MFs. Investing into direct equity (stock market) with little or no knowhow could be disastrous. That said, an early beginning in investing through equity MF also inculcates a disciplined and safe way of navigating the volatile stock market.

Options within equity

 Equity MFs come with multiple variations within the category, depending on the type of stocks they use to build the portfolio. Needless to say, the risks associated with each equity MF scheme also vary.

Large-caps. Typically, a large cap MF would invest in the shares of companies that have a market capitalization (market price of share multiplied by shares outstanding) of more than `5,000 crore. Generally, these funds are well-diversified among the top 30, 50, 100 or 200 stocks, and stick to stocks that have a high level of trading volume—thus, imparting enough liquidity to the portfolio. These are the least-risky among diversified equity funds, as shares of large-cap companies are considered to be among the best-known and most researched. They provide stable growth during periods when the stock markets are in a bull phase and tend to have lesser declines during downturns. Ideally, these funds should form the core of your investment portfolio and will be the main growth engine.

Mid- and small-caps. MF schemes that invest in shares with a market capitalization of anywhere between `1,000 crore and `5,000 crore are mid-cap funds. Small-cap funds target those with lower market capitalization—anything less than `1,000 crore. Mid- and small- cap funds are more risky as they invest in relatively smaller companies, which are in the growing stage and may be under-researched. As such, funds venture into the relatively unknown, and, therefore, the risk-reward ratio is also high. The mid- and small-cap segment is a 10 good investment opportunity for long-term investors who have considered both the returns and the risks. Before you decide to invest in a mid-cap fund, remember that it cannot form the foundation of your portfolio. It should be included only to the extent permitted by your risk profile to enhance the returns from your portfolio.

Multi-cap. While it’s the large-caps that take the centrestage, at times, mid-caps are considered favourites. Typically, no investor should change his or her MF portfolio to reflect the current stockmarket trends, since equity MF investments are always made to fulfil long-term financial goals. But, sometimes, to cater to such immediate tweaks in the portfolio, one may consider multi-cap funds, which invest across the spectrum of market capitalisation with a mix of large- and mid-cap stocks.


Derisking. Putting to use debt funds during the Derisking g phase helps. With about three years away from meeting your goal, start shifting funds from volatile equity into less volatile debt funds. Either switch funds in lump sum or use the systematic transfer plan (STP) to shift funds from equity to debt funds. The STP mandate will shift funds from existing equity scheme to any debt scheme of same fund house or another over regular period such as monthly or quarterly. As the shifting is staggered not all funds move out of equity in one go.

Regular income for retirees. Debt funds may be put to use by retirees too especially when they depend on regular income. For this use the systematic withdrawal plan (SWP), mostly available with debt schemes to fetch regular income. Basically, it’s a payment plan that lets you withdraw pre-decided amounts from your investments at periodic intervals. There are two options in an SWP—fixed withdrawals, in which you specify the amounts you wish to withdraw from your investment on a regular basis, and appreciation withdrawal, in which you can withdraw your appreciated amount. For those in the highest tax bracket, the fixed withdrawal option is more suitable and that too after holding on to the scheme for a year.

Tax-saving Mutual funds to create wealth

An MF investment also helps in planning one’s taxes and thereby reducing the tax burden. Investing in specific MF schemes called Equity-linked Savings Schemes, popularly known as ELSS, reduces one’s taxable income by the amount invested (up to `1 lakh as per Section 80C of the Income Tax Act, 1961) and, thereby, reduces his or her tax liability.

ELSS could be the starting point for new investors, as it offers market-linked returns with shorter lock-in period, as well as the benefits of tax-saving. ELSS can be used for creating wealth to meet your long-term financial goals. 11 Creating Wealth with Mutual Funds As the name suggests, an ELSS is a savings scheme that’s linked to equity.

Investment avenues for your savings can be a mix of various asset classes, such as equity, debt, gold and real estate. Technically, an ELSS is similar to any diversified equity MF, which routes your investments into the equity markets. Like any other MF scheme, ELSS is also managed by professionals known as fund mangers. It stands apart from a normal MF as it carries a tax benefit on the amount invested and, thereby, has a lock-in period of three years. Before you invest in an ELSS, estimate your total tax liability for the year. Then, based on your risk profile, choose among various tax savings instruments, including ELSS, and link it individually to your long-term goals. If properly chosen and cautiously maneuvered, ELSS can be a good kicker in your MF portfolio over the long term.

Managing the portfolio

Monitor your portfolio regularly and track the performance of the MF schemes you have invested in. Track your scheme’s NAV every six or 12 month and look for changes in the portfolio. Compare the scheme’s performance with that of the Senses, or its peers. If your schemes have not done well for a over year or two, find out whether it is because of a depressed capital market or due to reasons specific to your scheme’s performance.

Don’t get hassled if your scheme underperforms in a runaway market. But, if it is underperforming in a falling market (the fall in the scheme’s NAV is greater than the fall in the benchmark index), review your investment. You must read the fund manager’s comments in the newsletters and the annual report. Ensure the fund is adhering to the objectives stated in the scheme information document. Also, keep track of various periodic statements, such as newsletters, half-yearly and annual reports.

Source_Creating wealth through mutual funds.

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