I came across this ad when I was watching CSK vs MI match,
Where Shreyas iyer would be concerned to know the performance of different mutual funds,
Knowing that his friend Rohit Sharma reveals there is a website called Mutualfundsshaihai.com where you can know the performance of all the mutual funds,
And puts the disclaimer Past performance won’t necessarily indicate Future Performance,
Ask yourself “Why to invest in mutual Funds”?
It’s shouldn’t be like someone told they are doing it and getting great returns,
You also have to do the same,
This is money game, different people have different investing goals, different risk profile,
I’ve discussed different types of mutual funds with practical scenarios in this post.
So figure it out what suits your need,
What is financial literacy and why is it important:
Let me tell you a story,
Years ago when I was a kid a gentleman used to come to my house,
He used to have a discussion with my parents and with my brother about insurance schemes, saving schemes, tax saving schemes and all.
Those days when I was a kid I’ve observed it but never bothered about it.
Years passed….Now I’ve become grown up a kid and I’ve started asking questions to my parents about their savings, investments and expenses.
With that I came to know, that gentleman has suggested to start investing in mutual funds as well.
Surprisingly, my parents have migrated from traditional investments to mutual fund.
Part of the FD and RD savings have been moved to SIP and lump sum investment in mutual fund,
SIP is like RD and lump sum is like FD, don’t worry if you’re new to these terms I’ve discussed in detail in the later part,
My parents are happy about their SIP, since it has given double digit return, they are doing it for the past 9 years, invested Rs.1000 per month and allowed it grow over the period of time.
But on the other side lump sum invested money is not doing great.
Before 4 months market value of invested amount was 30% down,
When my parents saw that in the monthly statement they were shocked, panicked and thought of redeeming it,
Somehow they convinced themselves that it will recover in a period of time,
Last month when they came to know the money got recovered to the invested value they were happy.
But their biggest concern was had they invested in FD they would have earned some return in 2 years,
Here comes the importance of financial literacy,
Mutual Fund is a whole different ball game when compared to FD, RD.
In FD, RD you deposit in the bank, stick to the guaranteed return, Job done.
For the last 3 decades my parents are used to that and suddenly when they are exposed to market fluctuations imagine how their behavior will be.
That gentleman who is a mutual fund distributor, he did a great job in recommending better ways to grow the money efficiently.
But he didn’t assess the risk profile of my parents, haven’t discussed about their goals for investing, time horizon and did not make them aware of different scenarios possible.
Financial literacy means it is a ability to understand and efficiently use of various financial skills such as personal finance management, budgeting and investing.
In this post, I’ve focused on investing on how to grow the hard-earned money through one of the efficient ways.
Why to invest in Mutual funds:
If you’re a newbie in investing let me put in simple terms what is mutual funds investment and how it works,
By looking at the above diagram you would have got some idea,
Mutual fund house will get money from pool of retail investors like you and me can be as low as from Rs.100 to as high as Rs.100 Crores,
Fund manager would invest that in stock market, bond market and make returns out of it with his/her expertise in investing.
Then that return would be distributed to you and me for the money invested.
To define it, mutual fund is a vehicle which allows you to invest money in various asset classes like equity, debt, gold, which will be managed by competent and experienced fund managers in the country.
I hope now you would have got a broader picture of how it works.
Different types of mutual funds:
What are debt mutual funds:
Liquid mutual funds :
Last week, when I was talking with my friend this topic came in,
I asked him why don’t he consider investing in mutual funds instead of keeping the cash idle in savings bank account,
He told he is paying off his loans and taking care of family expenses so he might need cash at any point of time,
This is a very short time liquidity need,
So I’d want him to consider Liquid mutual funds where the time horizon is between 7 days to 91 days,
Let’s say if you invest today and suddenly you are in need of cash within 20days, you can redeem your investment at the time without any penalty charges,
That’s the beauty of this product,
You will get return for 20days for the invested amount,
If you see the historical yearly returns are around 4% to 5%, which is higher than the savings bank rate which is only 2.75%.
Ultra short term funds:
If you’re planning for a vacation in near future any time between in next 3 months to 1 year,
I’d want you to consider Ultra short term funds where the time horizon of investment is between one month to 1 year.
Benefit in this fund is you get slightly higher returns than liquid funds, historical yearly returns are somewhere around 5% to 7%.
If you keep money idle in the savings account you may end up swiping at any point.
See the potential problem of having money in the hand.
By investing, you kill two birds with one stone, it will fetch you better returns in the future and stop you from unnecessary current spending.
Beauty of this fund is you can redeem your investment at any point of time if you are in need of cash with no penalty charges,
In case in FD you would be getting less interest than usual if the money is taken in between, which is not in the case with mutual fund.
Short term debt funds :
Next is short term debt funds which you can consider investing if your time horizon of investment is between one to three years,
Historical yearly returns are in the range of 7% – 9%,
So I’d want you to consider this fund as a alternative for fixed deposits and recurring deposits which would give you only 5.5% to 6%.
As we can see clearly mutual funds have given extra returns compared to traditional investments you would be wondering what stops you and me to invest,
Above discussed types of funds comes under debt mutual funds, In a nutshell debt mutual funds will lend money to companies and get fixed returns for the investment,
The degree of fluctuation is minimal in debt funds compared to equity funds,
But holds some amount of risk compared to bank deposits,
It’s quite obvious that there is no such thing as free lunch, as you’re taking risk within your capacity you deserve that extra return.
Equity Mutual funds:
These funds buy shares of company from exchange which means directly buying the part of the business,
For example: If you feel companies in IT, Pharma, Banking sectors will do better for next few years you can consider investing in equity mutual funds.
Beauty of mutual fund is you don’t need to select individual companies,
Give money to mutual fund houses where fund managers will pick good stocks based on rigorous analysis performed by the team of financial analysts,
If you see long term statistic, historically returns from these funds are quite high compared to debt funds ranges from 10% to 12%,
Of course extra returns comes with extra risks, the degree of fluctuation is quite high compared to other category funds.
Time horizon for this fund ranges from 6 to 8 years,
Because companies go through good and bad economic cycles,
Normal business cycle in India is 6 to 8 years, this is why minimum time horizon should be that much.
Remember you’re investing in the part of the business,
If you want best promoter of the country to work for you for Rs.100 they are doing because you’re owning their shares through mutual fund vehicles.
What is SIP (investment plan):
SIP stands for systematic investment plan,
Traditionally our grandparents, parents have deposited money in banks as fixed deposits or recurring deposits as monthly savings,
Why was it RD, because cash flow to Indian households is monthly, we earn on monthly basis and save on a monthly basis.
So the concept of monthly investing in mutual fund is called SIP.
If you choose to invest in Ultra short time funds for one year, decided to invest Rs.1000 every month,
You can choose any date from the month, money will be auto debited from your account for all the months,
After one year you can redeem the invested amount and enjoy the returns as well.
Lump sum investment is one time investment which means invest Rs.10,000 at a single go and redeem at the maturity date.
Both style of investments has their own strengths and weakness,
So you have to be careful in selecting which suits you.
India is a country with more than 50% population are middle class,
Being one, I’ve observed my parents are prudent in terms of financial planning, they try to avoid all sort of risks and prefer to be conservative.
I really appreciate them for their discipline in terms of saving because that has paid off a great education for us(for me and my sister).
But the flip side is their generation financial literacy is very less for several reasons.
They did a pretty good job in savings but they are not aware of hidden potential problems in it.
But today we are in the digital generation, internet has penetrated like anything,
With that help of that, I thought of bringing it to your notice to make you,
Understand the impact of inflation on investment with practical examples and
I’ve discussed few investment options to stay financially healthy in the long run.
Are you active in Personal money management?
Till college, we were financially dependent,
I remember it was two years ago, that is 2-3 months after college got over,
I was preparing for CFA Level 1 exam and many of my friends have started their job.
It means they have become financially independent.
I was bit curious to know what they did with their salary.I’ve asked them shamelessly.
Answer was pretty common few were paying off the loans, few were taking care of part of family expenses, in addition to that managing their own expenses as well.
That’s good to know because people have become quite responsible ,able to manage of their own and started supporting their family financially.
But deep inside one thing has kept on bothering me.
Being from a finance background I think I’m hard-wired to think in this way.
Let me share my thoughts on it,
Speaking about the savings and investment part,
People are less active in personal money management area,
Heard of this warren buffet quote “Don’t save what is left after spending but spend what is left after saving”
This might have given better perspective on what I am talking about.
Hardly people around me spoke about savings and investments,
Few of them told they have started saving in the Fixed deposit and Recurring deposit(Sounds good)
Very few of them told they have started investing in mutual funds, trading directly in stock market. (Quite impressive)
But many of them told they kept their salary in the savings bank account, (Which is not financially good in the long run)
I’ve put people in two groups in terms of making their financial plan,
1)People are busy and have no time to think about it.
2)People have given thought about it and doing it to their capacity but looking forward to make it more effective.
If you’re in the first group, read till the end to know the potential problems of not making a effective financial problem
If you’re in the second group , Congratulations!! You’re in the right place.
What is inflation with example:
How to work on for effective personal financial plan in the long run?
For that you have to understand this simple concept from the economics.
Don’t be scared, if you are not from commerce background, neither do I.
So I tried simplifying it for your understanding.
What is inflation….Heard of it?
Which means price of goods and services will increase over the period of time.
Few of them might be aware of this already, few might be thinking, heard of it but not bothered much about it.
See the historical inflation rate in India,
How this is affecting you and me,
We will understand inflation with simple example,
If you see the inflation rates in India are 3.4% ,4.5% for 2018 and 2019 respectively and estimated rates are 3.3% and 3.6% for the future,
For the ease of understanding and calculation, assume inflation rate will be 4% for next 5 years,
Example: Imagine for a moment you are buying 1kg Onion +1Kg Potato + 1Kg Tomato for Rs.100 today.
In 2025, that is in 5 years for the same (1kg Onion +1Kg Potato + 1Kg Tomato) you would be paying Rs.122 due to inflation, each year there will be 4% increase in price of goods and services that we consume in day to day life like house rent, transportation expenses, groceries, apparels, education expenses and in other similar things.
This is for understanding purpose, I hope you got the broader picture.
On the other side you are getting salary, after all your expenses and liabilities are met, what’s happening to the remaining money,
Option 1: You’re busy and didn’t find much time to think about it, so just left in the savings account itself.
Option 2: You might be depositing in the bank and get “guarenteed” returns
Option 3: You might be Investing in assets like gold, real estate, mutual fund, stocks and grow the money.
Investment Options to beat inflation:
Let’s discuss one by one,
How much do you earn in a savings account :
Imagine you got your salary, as you’re busy you just left it in the savings account itself.
I would like to continue with same example to make it easy for understanding,
Assuming Rs.100 is remaining in the bank savings account after all your expenses and liabilities are met
Since that is left in the savings account, bank will offer a very low-interest rate of return.
Assuming you are an account holder in the “Bank for every Indian” that is in SBI.
It offers 2.75% interest for one year …If you left the money in a Savings account, in the next five years Rs.100 would have become Rs.114.
By looking that we can say Rs.114 in 5 years doesn’t hold the same value of Rs.100 in today’s value.
Remember the inflation example (1kg Onion +1Kg Potato + 1Kg Tomato today’s price is Rs.100),In 5 years the same amount of goods will be Rs.122,
See Rs.100 in your hand today is enough to buy all the vegetables but if you left it in the Savings account for the next 5 years then you can’t buy the same amount of vegetables at that time with this amount.
Money in your hand is grwoing at 2.75% but price of goods and services around you is increasing at 4%.
Technically, you are not earning any return, its negative 1.25%. In long run, inflation will have a effect on your saving which won’t be obvious to notice.
If you aren’t aware of this before I strongly recommend you to think about it and take decision after that.
How inflation affects Fixed deposit:
Assuming you are a type of person who is highly risk averse, conservative, prudent and loves the word “guarnteed” “assured” return like my parents.
Again assuming you are a account holder in the “Bank for every Indian” that is SBI.
No personal bias towards the bank, it is coming automatically because this is the only bank I’m holding an account for last 6 years.
SBI 5-Year Fixed Deposit rate is 5.4% which means if you deposit Rs.100 today, in the next 5-years you will get Rs.130.
Remember the inflation example, (1kg Onion +1Kg Potato + 1Kg Tomato) today’s price is Rs.100 , In 5 years the same amount of goods will be Rs.122,
If you see in the absolute terms you get only 8 rupees due to inflation (not 30 rupees).
Bank gives you 30 rupees but inflation eats up 22 rupees.
Real return is just 1.4% [Which is calculated as Bank deposit rate(5.4%) – Inflation rate (4%)]
This is a rough calculation just for your understanding, hope you got the braoder pictrure.
Take away point: Return from FD is slightly higher than inflation, but in real return terms it is marginal in nature.
How about Option 3,
Assuming you’re a type of person who are less risk-averse compared to the above category, expecting to grow the money in an efficient way within your risk appetite level.
You might be interested to Invest in assets like gold, mutual fund, stocks etc.
Gold investment returns in India:
Gold is a classic asset even my parents who are highly risk averse like to buy it.
But wait for a moment, are you buying gold as a investment or in the form of jewellary.?
Because in jewellary it’s quite complex to figure out the returns, there are hidden charges like making charges, wastage charges and all.
I’m assuming people who perceive gold as a investment who invest in it digitally or may be bought as coins.
Speaking about the historical gold prices in India,
In the above table, I’ve fetched the price of gold for respective years from google.
In 2001-2010 decade, there was a steep increase in the price. [5x increase of price in 10 years] which is massive.
After that price was flat, gradually increased for next 5 years. (2011-2015).
In the last 5 years, there was a decent upward price movement, especially in the past 6 months there was a good rally see 13k increase in last 9 months.
Speaking about the return from gold investment,
For the last 4 years, yearly rate of return is 12.5%. (2016-2019)
For the last 9 years, yearly rate of return is 8% (2011- 2019).
Remember the inflation rate in India which we have discussed above, somewhere around 4%.
Investment in gold would have beaten inflation with big difference.
Seems better investment opportunity right.?
Yes it does, but according to warren buffet, he told “Don’t put all your eggs in one basket”
So we can’t rely only on gold to grow the money, as there are tons of factors to drive the price.
Bottom line: Consider digital gold investment or buy as coins to diversify the portfolio.
Mutual funds return:
“Mutual fund investments are subject to market risk so read the document carefully before investing”
This is the discalimer we keep on hearing from different media channels when they advertise any mutual fund schemes.
If I start speaking on that I’ll end up writing the same length of what you have read already.
So I’ll reserve it for some other day.
Sticking to the topic, as we have discussed the returns of other investment class, we’ll do it for Mutual fund and see how much return it generated more than inflation.
Mutual funds are broadly classified as Equity Mutual fund and Debt mutual fund.
Equity Mutual Fund is further classified into bluechip funds, large-cap, mid-cap, small-cap funds.
In general, considering the diversification Equity Mutual Fund has generated 5 year-CAGR ( yearly return) of 10-12% in the past 5-years.(2014-2019).
This is based on average, many funds have generated more than 12% and , less than 10% even negative as well.
It all depends on the selection of funds and how effectively it’s managed.
Debt funds on average has generated 5 year-CAGR ( yearly return) of 7-9% in the past (2014-2019).
Remember the inflation rate in India which we have discussed above, somewhere around 4%.
Investment in mutual fund would have beaten inflation with very big difference.