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Wednesday, February 17, 2021

Are mutual funds meant for long term investments?

To be precise, equity mutual funds are meant for long term investments.

The reason is simple. Equity mutual funds invest the money in the stock market. The stock market is volatile in nature. It means the returns are not fixed. I nthe short term, the stock market is more volatile but in the long term, the market trajectory is always towards an upward direction.


Let me explain this volatility with an example of a large-cap equity mutual fund performance during Covid19:

Case 1:

  • If you had invested Rs 1 lakh in Kotak Bluechip Fund - Direct growth just one year ago in Nov 2019, then by March 2020 (within 4 months), you would have lost 33% of your investment value.

Now, just imagine what would be your reaction?

If you are someone who has no idea about how a mutual fund works, you would simply panic! You would think - “What a mistake I have made! Within 4 months, I have lost Rs 33,696. If I continue further, I might lose all my money. So let me exit from this fraud of mutual fund.”

Well, I won’t blame you. Anyone without knowledge about mutual funds would panic with such a loss. Just imagine, if you had invested Rs 5 lakh then you would have lost Rs 1.68 lakh!


Case 2:

But, on the other side, if you had invested Rs 1 lakh on 23rd March 2020 then what would be your investment value by now?

Wow!

Within 8 months, your Rs 1 lakh would be worth Rs 1.66 lakh! That’s a profit of 66% or an annual return of 120%.

Do you know why such a huge difference in return?

Because the market crashed in March 2020 due to Covid19. Hence, if you had invested before the crash, your portfolio would be in red. But, if you had invested during the crash, you would have made a great profit after market recovery.

Obviously, these are specific examples that I have picked just to show the extreme volatility in the market in the short term.


Case 3:

What could be a more realistic scenario?

If you had invested Rs 1 lakh in Nov 2019 and continued till date i.e. almost 1 year, your portfolio would be worth Rs 1.1 lakh.

During this period, the market crashed and recovered.


Case 4:

What if you had made a SIP of Rs 10k/month?

You would have invested Rs 1.3 lakh and your investment value would be Rs 1.5 lakh! Now, this is the most realistic scenario.

Do you know why the returns are better in the case of SIP?

Simply because you invested even when the market crashed. That’s rupee cost averaging. You purchased more units of a mutual fund when it’s NAV fell down.

But the problem is that a lot of investors do not understand the importance of consistent investment for the long term. Many investors fall under case 1 where they invest in the short term and if the market fall, they panic and sell their investments.


If you want to create wealth, you need to invest in mutual funds for the long term.

Do you know how much you would be worth if you had made a SIP of Rs 10k in this same Kotak Bluechip Direct Growth Fund 5 years ago?

Your Rs 6.1 lakh of investment would have fetched a profit of Rs 2 lakh with an annual return of 11.39%. Now, these 5 years include the Covid pandemic, demonetization, GST glitches, US-China trade war, etc. In spite of all these problems, the returns are still great! Hence, if you invest in the equity mutual funds for the long term, then you will fetch good returns.

Just to give you an idea, the same Rs 10k/month if invested in a fixed instrument like FD at ~6% return would have given a profit of Rs 1 lakh in 5 years. (Note: We have not considered the taxation. If we consider taxes, the returns from FD would be even lower than mutual funds)

Having said this, if you are looking to build an emergency fund where you can park your money for the short term and can access it anytime with minimum volatility in returns then you have the option of debt funds like liquid fund, money market fund, etc. Although the returns are not fixed on debt funds as well, you can expect an annual return of 6%-8%.

PS: I opted for Kotak Bluechip Fund only as an example. Mutual fund selection should be done on the basis of financial goals and risk appetite and it would vary from person to person. It is important to build a diversified mutual fund portoflio.

If you invest in Kotak Bluechip fund and want to know where exactly your money is getting invested, you can check the portfolio of the fund. Here is the latest portfolio:

So out of your Rs 10k, Rs 956 would be invested in Reliance, Rs 808 would be invested in Infosys, Rs 789 would be invested in HDFC bank and likewise. But the fund manager would keep churning the portfolio every now and then. This portfolio is as of 31st Oct 2020.

Note: All these screenshots are from moneycontrol website.

Source : Sahil Bhadviya

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