Features like systematic investments and step-up should be used to initiate new investors into mutual funds
Your portfolio should be in line with the asset allocation that best meets the need for liquidity, income, growth
In one edition of the Mutual Fund Sahi Hai campaign by the Association of Mutual Funds in India (Amfi), cricket maestro Sachin Tendulkar recommends overnight funds as the best option for new investors to start investing in mutual funds. He likens it to net practice in cricket, or the idea of preparing for a real match.
Can one category serve as “net practice" for mutual fund investors? Is the idea of a fund category being an entry point for new mutual fund investors a valid proposition? Unlike net practice where a cricketer would practise before the main game, mutual fund categories are quite distinct in terms of risk and return, especially funds focusing on different asset classes like debt and equity.
If an investor, who is introduced to mutual funds through, say, overnight funds (like the campaign suggests), assumes that all other categories are going to be low-risk and low-return, then he will be in for a rude surprise. The investor will be unprepared for the volatility in returns in other categories, such as equity funds and debt funds with longer durations. On the other hand, an investor looking to mutual funds for better returns than traditional fixed-income investments may be disappointed by the low returns from overnight funds. Both these categories of investors are likely to be put off by the net practice in overnight funds and may even decide not to “play" the game and not invest in mutual funds at all.
However, what investing in overnight funds as a starter fund may help to do is to familiarize a person with the overall experience of investing in mutual funds. It may make him more comfortable with ideas like variable returns, which is an essential feature across categories.
So while overnight funds may not serve this purpose, which other categories can new investors in mutual funds look at?
What should new MF investors do?
Choose according to need: Investment advisers believe that for a sustainable investment experience, new investors should consider mutual funds that suit their needs. “I suggest products to my investors given their goals. It is my responsibility to explain the features of the product, including risk, and how it will be managed," said Deepali Sen, a certified financial planner and founder partner of Srujan Financial Advisers LLP, a mutual fund distribution firm.
Look at risk and return: When investors make well-informed choices aligned to their goals, there are less chances of getting unwelcome surprises on performance.
Renu Maheshwari, CEO and Principal Advisor, Finscholarz Wealth Managers LLP, a Sebi-registered investment adviser, agrees. “The first product can be any product that meets the risk and return preference of the investor. For a first-time investor we would, however, avoid the more volatile products in an asset class, say, a dynamic or gilt fund among debt funds," she said.
Shift gradually: Sometimes new investors are unwilling to buy a product that is best suited to them, because of their discomfort with risk. In such instances, it is important to understand their specific reservation and start with products that will address it.
“Sometimes clients are uncomfortable with volatility in returns of debt funds despite our efforts to educate them. In such cases, we may start them off on an ultra-short or other low-duration debt products which have marginal volatility. Once they are comfortable with the idea of volatility and how it will be managed, then move them to products that suit their investment horizon," said Sen. “I make sure they know and understand that the volatility in the new category will be higher than what they have experienced in the lower risk category. It is easier to make them understand how its impact will be managed," she added.
Advisers allay fears by using other methods too such as showing historical data to the clients. “Investors have concerns about losing the money invested and the volatility in returns. We assuage the concerns with data on historical performance where there have been periods when investment value has depreciated and then recovered again. We give them the assurance that their life goals will not be affected by the vagaries of the market," said Maheshwari, pointing out to the importance of linking investments to goals.
Risk is a need too for investors to meet their goals efficiently, said Sen.
The bait products: Some advisers use fund categories, where the results of investing to meet a need are seen quickly, as a bait. “The liquid fund works well as a first fund for investors looking for better returns for the short-term balances held in the savings account. For investors with holding period of one to two months, the better returns relative to the savings bank account are immediately visible and the marginal volatility in this category is also not a concern," said Gajendra Kothari, managing director and CEO, Etica Wealth Pvt. Ltd, a Sebi-registered investment advisory firm. Once they see their need of better returns combined with liquidity and lower risk met, it is easier to introduce other fund categories to them, he said.
Liquid funds that can find a place in most portfolios as a way to hold the emergency fund and other short-term balances.
Similarly, gold funds offered by mutual funds can easily find a place in most investor portfolios, both for diversification benefits as well as tactical gains. Given Indians’ penchant for gold and the comfort with volatility in the price of gold, there may be comfort in starting off with a gold fund. Gold funds and exchange-traded funds (ETFs) score on providing a low-cost, safe and liquid and convenient option to investing in gold. “For investors looking to make tactical gains from gold price movements the gold funds and gold ETFs are good products," said Maheshwari.
An investor’s portfolio should be in line with the asset allocation that best meets the need for liquidity, income and growth. Each mutual fund product category meets a particular need. Investor awareness about the risks that various products have and how they can be managed is an important step in the investment process.
Besides the risks of volatility and loss of capital, risks like loss of real value as a result of inflation and its impact on goals are equally dangerous and should be understood properly. The risk of inflation eating into returns is experienced when investors look for safety in products like overnight funds.
The focus of building a portfolio should be on managing risks and not eliminating them since that will have consequences on the returns.
Features like systematic investments and step-up should be used to initiate new investors into mutual funds. As their comfort with the product goes up, they may increase their investment amounts in line with their goals.
Last but not the least, choosing a competent adviser can lead you to the right path without you losing time and money on experimentation and net practice.