importance of financial literacy

Have you seen this ad before?

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,

what is mutual funds investment

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,

Risk???????

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.

different types of mutual funds
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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

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.

For example,

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.

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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.

Conclusion:

Compared to other investment options, mutual fund is one of the best possible ways to beat inflation in a long run.

Before finishing I’d want to emphasis on this,

The above material is only for educational purpose,

Consult your financial advisor before making any investment decisions,

Happy investing !!

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4 Comments

  1. Nice article Subramanian. It would really help the people who have very little idea on investing their hard earned money.

  2. Wish you all the best on your future endeavours and this article is really easy to understand by any common man like me.

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