Are myths about mutual funds holding you back from making informed investment decisions? If so, this article is for you. It explains seven common misunderstandings about mutual funds and gives you the real facts.
Myth 1: Believing that investing in schemes with lower Net Asset Values (NAVs) will lead to higher profits.
Fact: The NAV represents the unit price at which you can purchase or sell a particular scheme. Therefore, the NAV, whether it’s Rs 50 or Rs 500, doesn’t directly correlate with the potential returns on your investments. Factors such as the scheme’s rate of return, its performance, and its level of volatility should be considered when assessing potential gains.
Myth 2: Believing that purchasing a fund when it announces a dividend is a favourable strategy.
Fact: Dividends are declared by funds when they have accumulated surplus profits from their holdings. This surplus profit remains within the fund until it is distributed to unit holders, and this distribution is reflected in the NAV of the scheme. When the dividend is paid out, the NAV decreases to account for this change. Consequently, trying to time your purchase around dividend announcements doesn’t provide any advantages for investors.
Myth 3: The idea that you should sell when a Mutual Fund’s NAV is high and invest in schemes with low NAVs for better returns.
Fact: When you purchase individual shares, you typically monitor the share price and sell when it increases above your purchase price. Mutual fund schemes, on the other hand, pool money from investors and invest in various assets. The NAV of a mutual fund is calculated by subtracting the scheme’s liabilities from its assets and then dividing by the total number of units.
It’s important to understand that a high NAV doesn’t guarantee excellent returns, just as a low NAV doesn’t suggest otherwise. The NAV alone doesn’t determine the potential for good returns in a mutual fund. Other factors like the fund’s performance, the assets it holds, and the market conditions also play a significant role.
Myth 4: Mutual fund investments rely on perfect timing.
Facts: Many investors mistakenly believe that successfully timing the market is the key to successful mutual fund investments. However, trying to time the market often leads to poor results, and financial experts typically discourage this approach. Instead, investors are advised to consider options like Systematic Investment Plans (SIPs) or Systematic Transfer Plans (STPs). These strategies enable investors to benefit from Rupee Cost Averaging, which can be a more reliable way to navigate the ups and downs of the market over time, rather than attempting to predict and time market fluctuations.
Myth 5: SIP and STP are identical.
Facts: While SIP and STP may sound similar and offer some comparable benefits, they operate differently. In a SIP, you invest a fixed amount at regular intervals. When the market is at higher levels, you purchase fewer units, and when it’s at lower levels, you buy more units. Over a long investment horizon, this results in cost averaging, which can potentially lead to a lower overall purchase price.
On the other hand, STP stands for Systematic Transfer Plan and involves transferring a fixed amount at predetermined intervals, as per the investor’s mandate, from one scheme to another. The key distinction lies in the way they manage investments and the ultimate purpose of the strategy.
Myth 6: Assuming that dividend pay-out and growth options in mutual funds are identical.
Fact: Dividend pay-out and growth options in mutual funds are not the same. In the dividend pay-out option, any dividends declared by the scheme are distributed to the investor. In contrast, the growth option retains these earnings within the scheme, which is then reflected in the NAV of the scheme.
The dividend pay-out option provides investors with regular cash flows (depending on the availability of distributable surplus), while the growth option aims to accumulate returns over time, leading to a higher NAV and potential compounding benefits. These two options cater to different investor preferences and financial goals.
Myth 7: Believing that investing in Mutual Funds carries a higher risk compared to the stock market.
Fact: Mutual funds typically invest in a diversified portfolio of equity and/or debt instruments, guided by their stated investment objectives. Fund managers carefully select these investments to mitigate risks and maximize diversification. As a result, investing in mutual funds is often considered less risky than making direct investments in individual stocks. However, investors need to seek advice from financial advisors before making investment decisions to ensure that they align with their financial goals and risk tolerance.