Why you should think Long-term when investing in Equities?

When it comes to investing for your future, there are a lot of stocks and investment to choose from. Although there is no specified formula or handbook that investors are expected to follow, there is one general rule: “Invest for the long-term and buy in dips”. Don’t bother about the Market position whether it is all time high or all time low.

If you need funds for the short term, investing in stocks is not encouraged as by the markets leaders because of the nature of volatility of market and can swing in either direction based on a lot of factors. That is why, in India, gold and real estate are preferred investment options. However, if you’re looking to your returns 5 or more years into the future, an investment in equities or an equity fund can be ideal.

Here are reasons why long term planning is essential when investing in equities:
1. Power of compounding
Your age and financial responsibility play an important part in your investment decisions. Since youngsters have fewer financial responsibilities such as retired parents, a spouse, children, or car or home loans to pay off, they are encouraged to start their investments early. A young individual also has a high risk-bearing capacity, being able to withstand the swings of the market. Moreover, buying stocks or investing in equity for the long term allows you to take advantage of compounding.

Compounding requires two factors for it to work: the reinvestment of earnings, and time. The more time you give your investments, the more you can accelerate the income potential of your original income.

For example, an investment of 10,000 at 10% will result in 11,000 in one year. If you decide to reinvest the gain of 1,000 and receive the same rate of return, your capital will grow to 12,100 by the end of the second year. By contrast, not reinvesting the gains would have resulted in capital of just 12,000. This difference seems small over short time periods, but if one were to sustain the same 10% annual rate of return over a decade, the difference would show 25,937 for the reinvested corpus, versus just 20,000 total for the portfolio with gains pulled out of the market.

Year Starting Value Multiplier Interest Earned End Value
1 10,000 10% 1,000 11,000
2 11,000 10% 1,100 12,100
3 12,100 10% 1,210 13,310
4 13,310 10% 1,331 14,641
5 14,641 10% 1,464 16,105
6 16,105 10% 1,610 17,715
7 17,715 10% 1,771 19,487
8 19,487 10% 1,948 21,435
9 21,435 10% 2,143 23,579
10 23,579 10% 2,357 25,937

The above table is for illustrative purposes only.

2. The data doesn’t lie
Although there have been ups and down, history shows that if you align your portfolio for the long term, you’re more likely to make money, especially if you focus on high-quality businesses.

After the 2008 crisis, many investors terminated their SIPs. This was a really bad choice because the whole point of an SIP is to keep investing, irrespective of market conditions. Investments made when the markets are down big tend to make the greatest profits – as Warren Buffett says, “Be greedy when others are fearful.”

3. You can correct investment mistakes in the long term
Anyone can start a long-term investment; you don’t have to be an investment guru to invest in well-run businesses for the long term. An important thing to remember is that you will make mistakes; even the best investors have been wrong. But a regular review of investments every six months can help to correct at least some of these mistakes. It is important to hold on to companies that have historically demonstrated strong growth and add to companies whose business models are still intact but have fallen on hard times.


Growth or Dividend – How to make the right choice?

Mutual Funds offer three options:

* Dividend
* Dividend Reinvestment and
* Growth

Which is the best and why?

In my experience as a financial and investment planner, I have largely found that investors tend to give a lot of time and importance to the process of selecting a mutual fund. However, once a particular fund is chosen, choosing an investment option is done on an almost arbitrary basis. Some like the idea of receiving periodic Dividend, some like recurring investments and hence choose the Dividend Reinvestment option and others choose Growth. And some even leave the entire exercise to the discretion of the agent or distributor.

However, choosing the correct option is perhaps as important to the health of the investment as choosing the particular mutual fund is. What are the various factors one should consider and why?

There are two factors that are of prime importance when choosing an investment option – a. Fiscal policy b. Your investment needs and goals.

Both these factors play an important role and let us see how we can tweak each for the maximum benefit.

Choosing the Dividend Option – Drawbacks

Before considering the drawbacks, let us look at the benefit of choosing the Dividend option.

The foremost and the most obvious benefit is that the dividend is tax-free — in the real sense of the term. Though all MF dividends are tax-free, dividends received from non equity-oriented schemes are subject to a distribution tax of 14.025%. This means that though such dividend is tax-free in your hands, you are receiving 14.025% less than what you would have otherwise received. This by inference means that it is you who is bearing the 14.025% tax, the MF only pays it on your behalf.

Dividends from equity schemes do not suffer this distribution tax and hence are truly tax-free. Then shouldn’t all investors choose the Dividend option? Isn’t this entire discussion a non-issue?

Not so fast. Let’s consider a live example — that of Franklin India Prima, a scheme that has been in existence since November 1993.

As on 19th June, 2006, the NAV of the Growth Option of Prima was Rs 153.86 whereas that of the Dividend Option was Rs 48.99 – almost 68% lower. Why is this?

The difference is the dividend received by the investor.

It should be understood that dividend from a mutual fund, unlike stock dividend, is your own money coming back to you. Therefore, had you invested in the Growth option of the scheme, the NAV of Rs 153.86 would apply to you. But since you have chosen the dividend option, periodically, some of your investment amount was paid back to you (by calling it dividend) and hence the market value of your units is Rs 48.99.

Now, also note that the scheme performance is calculated based on the Growth option NAV. Actually, technically, it doesn’t matter, which NAV is chosen, as the dividends received are assumed to have been reinvested in the scheme at the Internal Rate of Return or the IRR. But without getting into mathematical jargon, it suffices to say that the Prima performance (which has been nothing less than spectacular) is based on the NAV of Rs 153.86 and not Rs 48.99.

So far so good. As long as you needed the dividend, all this really doesn’t matter. But my next question is what one should do when the dividend comes and sits in your bank? Do you reinvest it in the same scheme or for that matter into another scheme? If so, do realize that you are reinvesting the money in the same asset class — Equity. It needn’t have come out of the asset class (in this case Prima) in the first place! Plus you may have to bear a load for the fresh investment. Of course, your distributor is happy since this means extra commission.

The second problem is agility. You may forget that the scheme has paid dividend and the money is lying in your bank. It happens. Or even if you are well aware of the fact, the market is behaving in a whimsical manner and this volatility is delaying your decision to enter. The money again sits in your bank.

All this time, when the money relaxes in your SB account, the rate of return of your investment is falling. The reason is simple arithmetic. The capital that is invested in Prima is growing at the IRR as discussed above (44% for the last year, 69% over 3 years and almost 26% since inception). However, the dividend that is lounging in the bank is growing at just 3.5% p.a, which is the SB interest rate. Over time, this substantial difference in the two rates dilutes the net return on the investment. More the time spent in the bank, more the dilution.

Other Reasons for choosing Dividend
Of course there are a couple of excellent reasons given to me by investors for choosing the dividend option. One is of course, needing the funds for day to day life. The second one was that getting dividend in a rising market is like partial profit booking, which is good form. The funds representing dividend can be invested into fixed income avenues or even fixed maturity plans thereby rebalancing the asset allocation.

Excellent arguments that cannot be argued with, per se. Only one hitch. Unlike fixed income avenues (such as PPF, RBI Bonds etc.) when the interest is fixed, not only in terms of the amount but also the timing thereof, dividends from mutual funds are at the discretion of the mutual funds. One never knows how much would one receive and when. In other words, the fund manager may decide not to distribute dividend. Or he may decide to distribute much less than what you need. Or much more than what your intended shift of the asset allocation dictates. What do you do?

There is a simple solution. Ask for the dividend yourself.

Yes, you read that right. You can ask for the dividend. To put it differently —

‘When the MF pays you money, it is called dividend. When you yourself withdraw an equivalent amount, it is called capital gain!

We all know that after one year, withdrawals (capital gains) from a mutual fund are tax-free. Therefore, for your annual dividend requirement, do not depend upon the whims of the mutual fund concerned, instead withdraw the funds as per your requirement.

This way, you can earn dividend not at the whim of the Mutual Fund, but at your fancy! The value of your investment remains the same, whether dividend is paid to you by the MF or whether you redeem units of an equivalent amount.

To Sum Up
The psychology of investing, fiscal policy and your requirements from your investments, all go hand in hand in deciding the optimal option to choose from. As fiscal policy stands today, the dividend option doesn’t stack up against the alternatives. However, if tomorrow, long-term capital gains tax is imposed, this strategy wouldn’t work and the dividend option would once again come to the fore.


New Fund Offer: Things to note before you invest

Most of us like to try out new things whether its dining at restaurants, buying mobile phones and cars to name a few. Some go to the extent of changing mobile phones every 1 year and a car every 3 years. Well this is a matter of personal preference and lifestyle and might give you some kind of emotional happiness which is good in some sense.

But when it comes to most new funds, there is hardly anything different, unique or really NEW about it. It’s just that the name gets more exotic, dressing gets much better or a new marketing ploy such as Invest in India’s Growth potential as if other options available are not investing in India’s growth potential. (Also read – Have a Dravid and a Dhoni in your portfolio)

To put it simply most of the new fund offers are Old Wine in a New Bottle. They are packaged very smartly with fancy marketing ideas to entice the client to buy. There was a deluge of New Fund Offers in 2005 and early part of 2006.

SEBI on its part took a series of steps. Firstly, SEBI objected against the use of the word IPO and instead had every fund house use NFO (New Fund Offer), to confuse with Stock IPOs, to curb rampant mis-selling of new funds.

Secondly, SEBI had Mutual Funds launching open-ended New Funds charge the initial issue expenses within the entry load itself whereas close ended funds could still charge 6% initial issue expense. (Also read – Invest, but choose the right mutual fund)

This is precisely one of the reasons why most of the mutual funds have been launching closed ended New Fund Offers so they could pay a higher brokerage of around 5 to 6% to distributors.

Thirdly, SEBI has taken note of this deluge of similar funds being launched and made it mandatory for the trustees of Mutual Funds to personally certify that their new schemes are different from the old ones. Despite this some of the fund houses have been launching me too schemes.

Some fund houses such as DSP Merrill Lynch have not launched any new offering in the last 12-15 months, except for the Super SIP (which was a genuine attempt to offer something new that was relevant), whereas others such as Tata Mutual Fund and SBI Mutual Fund have been strong contenders for the Top Slot in the New Fund Euphoria.

So the question boils down to “How does then one decide if the New Fund Offer of the so many being launched every other month is suitable for me”.

Before answering this question, first 3 Common Mistakes all investor should be aware of:

(a) Too less or Too many aren’t good enough
I have seen many investors having anywhere between 16-85 funds or some who have just one or two. Having too many in the name of diversification is no good and in fact defeats the very purpose of diversification.

After all the one of the reasons you opt for a mutual fund is to diversify your investments but having all large cap funds in your portfolio is unlikely to do any good.

At best based on the size of your portfolio, spread your investments across in 4-9 different funds spread across different Mutual Funds, fund managers, investing styles, expense ratios, portfolio turnover, market capitalization and whether its an all equity, balanced, or tax planning fund. Give Sectoral funds a complete miss unless you are very bullish on the sector and understand the risks well.

(b) Rs. 10 NAV is not cheaper than Rs.100 NAV
What you should be concerned about is the% fall or% rise. A Re. 1 fall in a NAV 10 fund is the equivalent of Rs.10 fall in a NAV 100 fund. In fact Rs.100 means proven competence and a long track record of capital appreciation. (Also read – Demystifying NAV myths)

(c) Don’t fall for fancy terms
Don’t fall for fancy and general terms such as Investing in India‘s growth potential, Options and Derivatives to diversify your portfolio. See if there are any existing funds with longer track records with similar investment objectives & strategies.

If there are, opt for the tried and tested ones rather than going from newer exotic ones.

How to decide if the New Fund is an appropriate one for you?

1. Take a look at your Financial Plan if you have one or at your existing portfolio. What kind of funds do I have in my existing portfolio? Are they large cap funds, mid cap funds, flexi cap funds, balanced funds, tax planning funds?
2. The next to see is how does this new fund really add value to my existing portfolio? How does this New Fund fit into my portfolio, my asset allocation, and help achieve my goals? This is a million-dollar question.
3. Is this really a New Fund with an interesting theme that might fit well within my portfolio? Understand the investment objective, strategy and asset allocation of the fund.
4. What has been the fund manager’s track record of managing other schemes? Which are the other schemes managed by this fund manager? How have they performed in the past? Especially what has been his previous funds performance during tough times like the May 2006 mayhem, 2000 crash etc.
5. How stable is the investment team of the fund house and how many schemes are they managing? What is their track record of launching new funds? If the fund house is notorious for launching new schemes once every 2-3 months, you will be better off skipping such schemes or fund houses altogether. (Also read – 7 investment tips to improve your returns)
6. If after doing this, you still cannot figure out if you should opt for the new scheme, seek the advice of your financial adviser.


10 must-reads in an MF offer document

You would have come across this line in all Mutual Fund advertisements, “Mutual Fund investments are subject to market risks. Please read the offer document carefully before investing.” It’s an open secret that this 80 to 100 page bulky document is not simple to read and the legal information it contains is not easy to understand for most investors.

However, Sebi has made the investor’s job easier by evolving an abridged form, the Key Information Memorandum. Also, Sebi has served the cause of investors by stipulating standard sections and standard disclosures in all Offer Documents. Hence, the Offer Document can be the friend and guide of an enlightened investor. Here is a guide to what an Offer Document is, why it is important and what are the 10 Most Important Things to Read in an Offer Document for investors.

What is a Mutual Fund Offer Document?

It is a prospectus that details the investment objectives and strategies of a particular fund or group of funds, as well as the finer points of the fund’s past performance, managers and financial information. You can obtain these documents from fund companies directly, through mail, e-mail or phone. You can also get them from a financial planner or advisor. All fund companies also provide copies of their ODs on their websites.

10 Most Important Things to Read in an Offer Document:

Date of issue
First, verify that you have received an up-to-date edition of the OD. An OD must be updated at least annually.

Minimum investments
Mutual funds differ both in the minimum initial investment required, and the minimum for subsequent investments. For example, equity funds may stipulate Rs 5000 while Institutional Premium Liquid Plans may stipulate Rs 10 crore as the minimum balance. (Also read – How to reduce risk while investing?)

Investment objectives
The goal of each fund should be clearly defined — from income, to long -term capital appreciation. The investors need to be sure the fund’s objective matches their objective.

Investment policies
An OD will outline the general strategies the fund managers will implement. You’ll learn what types of investments will be included, such as government bonds or common stock. The prospectus may also include information on minimum bond ratings and types of companies considered appropriate for a fund. Be sure to consider whether the fund offers adequate diversification.

Risk factors
Every investment involves some level of risk. In an OD, investors will find descriptions of the risks associated with investments in the fund. These help investors to refer to their own objectives and decide if the risk associated with the fund’s investments matches their own risk appetite and tolerance. Since investors have varying degrees of risk tolerance, understanding the various types of risks in this section( eg credit risk, market risk, interest-rate risk etc.) is crucial. Investors must raw be familiar with what distinguishes the different kinds of risk, why they are associated with particular funds, and how they fit into the balance of risk in their overall portfolio. For example, a Post Office Monthly income plan assures an 8% monthly income payment for its 6 years tenure. A Mutual Fund MIP invests in a portfolio of 80% to 90% bonds and gilts and 10% to 20% of equities, to generate capital appreciation, which is passed on to customers as monthly income, subject to availability of distributable surplus. In 2004, a lot of mutual fund customers underestimated this market risk and were caught by surprise when the MIPs gave low/negative returns. (Also read – Fear interest rate risk? Here is the solution)

Past Performance data
ODs contain selected per-share data, including net asset value and total return for different time periods since the fund’s inception. Performance data listed in an OD are based on standard formulas established by Sebi and enable investors to make comparisons with other funds. Investors should keep in mind the common disclaimer, “past performance is not an indication of future performance”. They must read the historical performance of the fund critically, looking at both the long and short-term performance. When evaluating performance, investors must look at the track record of a fund over a time period that matches their own investment goals.

They must check that the benchmark chosen by the fund to compare its relative performance is appropriate. Sebi is doing a fine job of ensuring this as well. In addition, investors should keep in mind that many of the returns presented in historical data don’t account for tax. They must look at any fine print in these sections, as they should say whether or not taxes have been taken into account.

Fees and expenses
“Mutual funds have two goals: to make money for themselves and for you, usually in that order.”- Quote from Fool.com. Entry loads, exit loads, switching charges, annual recurring expenses, management fees, investor servicing costs…these all add up over time. The OD lists the limits on these fees and also shows the impact these have had on the fund investment historically. (Also read – How to build your MF portfolio?)

Key Personnel esp Fund Managers
This section details the education and work experience of the key management of the fund company, including the CEO and the Fund Managers. Investors get an idea of the pedigree and vintage of the management team. For example, investors need to watch out for the fund that has been in operation significantly longer than the fund manager has been managing it. The performance of such a fund can be credited not to the present manager, but to the previous ones. If the current manager has been managing the fund for only a short period of time, investors need to look into his or her past performance with other funds with similar investment goals and strategies. Only then can they get a better gauge of his or her talent and investment style.

Tax benefits information
Mutual funds enjoy significant tax benefits under Sec 23 D and Sec 115 .For example, Equity funds enjoy nil long terms capital gains and nil dividend distribution tax benefits. A close reading of the tax benefits available to the fund investors will enable them to plan their taxes better and to enhance their post tax returns. (Also read – How to ride the rising interest rate tide?)

Investor services
Shareholders may have access to certain services, such as automatic reinvestment of dividends and systematic investment/withdrawal plans. This section of the OD, usually near the back of the publication, will describe these services and how one can take advantage of them.


After reading the sections of the OD outlined above, investors will have a good idea of how the fund functions and what risks it may pose. Most importantly, they will be able to determine if it is right for their portfolio. If investors need more information beyond what the prospectus provides, they can consult the fund’s annual report, which is available directly from the fund company or through a financial planner.

This investment of time and effort would prove very beneficial to investors.


Is it time to say Goodbye to your fund?

Many investors are still to fully understand the concept of a mutual fund. They continue to treat it similar to investing in shares. Therefore, they tend to buy mutual funds for wrong reasons – low NAV of a fund; dividend announced by a MF; New Fund Offer etc.

The same misconception is seen in selling too. One of the most common instances of selling a mutual fund has been to invest in a New Fund Offer. This is under the false impression that a fund at Rs.10/- is cheap and an excellent opportunity to invest. Many investors have been misled by distributors into this kind of switching. (Also read – Invest wisely and get rich with equity MFs)

Further, the profit booking strategy for stocks may not strictly be applicable to mutual funds. It is the job of the fund manager to keep buying under-valued or fairly-valued stocks, while booking profits by selling overvalued stocks Therefore, by selling a MF from a profit booking perspective, we may actually be selling off a fairly valued portfolio – with a good long-term potential.

Therefore, what could be the possible situations for selling a MF?

Financing a need

A very obvious reason to sell would be when you need money. We all invest money with a view to finance some need or a desire in the future.

Say, you planned to buy a car or a house; or need to pay your child’s fees; or maybe you want to take a vacation abroad. All this would require you to liquidate some of your investment. (Also read – Trading tricks that’ve stood the test of time)

However, proper choice is essential in deciding which fund(s) to sell. You could either sell those funds, whose performance has not been encouraging; or those where the tax impact is minimal; or those where the amounts are not very significant; etc. Or sometimes, possibly it may be better to borrow rather than sell a good investment.

Poor performance

There are more than 200 equity funds and their number is growing. The returns from practically all funds have been comparatively quite good, given the current bull-run. Even the worst performing funds have given 30-35% returns in last 1 year. In absolute terms these are excellent returns. But when compared to the top performers with 110-115% returns, these look extremely poor.

However, the key here is to look at long-term returns – 1-yr, 3-yr & 5-yr – and compare it with both the benchmark index and other funds in the peer group. In the short term there could be a genuine reason for under-performance. Some of the investments may be from a long-term perspective; certain sectors may have been under-performers; contrarian investments take time to catch market fancy, etc. (Also read – The Investors biggest Dilemma)

But if the performance of the fund continues to be consistently below par over long periods of time, then it may be worthwhile considering switching over a better performing fund. If possible, one should also try and assess the reasons for poor performance. This will give a good insight into the market.

Rebalancing the portfolio

We all have a certain asset allocation across various investment options such as debt, equity, real-estate, gold etc.

A change in your financial position may require you to rebalance your portfolio. Suppose you are presently having a well-paid job and are unmarried with no liabilities. You can, therefore, take much higher exposure in equity MFs. But with marriage and kids your responsibilities may increase, which would require you to reduce you equity risk to more manageable levels.

Or the portfolio balance changes with time, due to different assets growing at different rates. Your equity portion may have appreciated much faster than your debt, distorting the original balance. Hence you would need to sell equity and re-invest in debt to restore the original balance. (Also read – Mutual Funds: Your best personal Portfolio Manager)

Or maybe a new asset class has been introduced in the market – a real-estate fund or a gold fund – and you want to take advantage of it. Thus you may have to sell a part of your existing investment and re-invest in this new asset class.