Why you should never invest in Mutual funds!!!

Most of us take the mutual fund route for stock investing. Most of us have not made significant profits in the stock market. Why?


Mutual funds offer us a convenient route to the equity market. The funds also advertise aggressively, and their agents come to our homes to get the forms filled, and take the cheques? Easy, isn’t it? However, wealth creation is not that easy, otherwise all of us would be already quite rich!!!


Let us examine the mutual funds in a little more detail.


A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests it in stocks, bonds, short-term money market instruments and other securities. Mutual funds have a fund manager who invests the money on behalf of the investors by buying / selling stocks, bonds etc. India has around 1000 mutual fund schemes.


How does it work?


The mutual funds sell their schemes through a vast distribution of distributors including your next door broker. For this the mutual funds pay a commission to the distributor. This includes a commission on new folio, and annual trail commission. Recently, SEBI has given leeway to pay  more commission to the distributors
#Cost A- This is your money, paid to the distributor on fresh buy and annual commission as a percentage of your portfolio.


The mutual funds advertise aggressively in the business magazines, newspapers, television and online to get  your attention. #Cost B- this is again your money.


The fund houses maintain a whole organization, including the star fund manager. The salaries of the staff, bonus of the fund manager, cost of maintaining a shining office in Mumbai, systems etc. is #Cost C- this is again your money.


Thus pretty much sums up the costs you are paying to invest in a mutual fund. All these costs are deducted from your NAV without you knowing about it.


Now, let us analyze what you get in return.


Most of the mutual funds can not meaningfully invest in micro/small cap stocks because of the following factors –


1. The market cap of the stock is too small compared to the size of the mutual fund.


2. The mutual fund needs to restrict portfolio allocation to small caps to a small number due to its mandate


3. The stock is too illiquid




Infact, most of the mutual funds have similar names in their portfolio. No prizes for guessing them- Reliance, ITC, Bajaj, ONGC, HUL, ICICI bank, HDFC Bank etc.


Also, many fund managers face a lot of peer pressure and have to keep the top large caps which everyone are buying  in their portfolio; the herd mentality!


Quality small caps give a lot more capital capital appreciation compared to the well known large caps. Small caps are under researched, low interest stocks because of their low market cap. For example, Hawkins Cooker was a 200 cr market cap company four years ago, and one share was at Rs. 200. Not even one mutual fund out of the 1000 funds was invested in it four years ago.  This formed 5% of my personal stock portfolio. Today, the stock is up 11 times, and is at Rs. 2230 and is expected to give good returns in future as well!


On the other hand, most large caps are well researched stocks and their analyst reports are very easily available online. The portfolio of mutual funds are also available online.


Wonder why should a retail investor pay these mutual fund managers to do this job?


If a retail investor can spend some time to research stocks, and invest 20-30% of his/her portfolio in small caps such as I had invested in Hawkins a few years ago, he/she can make much superior returns compared to mutual funds and create wealth. The other option is to search for an investment advisor who can give the right guidance to buy small cap stocks. Unfortunately, such advisors are too few in India.


A difference of even 4% return creates large difference in long term wealth creation. 18% return on Rs. 20 lakhs investment for 30 years will grow your investment to Rs. 29 crores, while 14% return will generate only Rs. 10 crores. A difference of Rs. 19  crores or 190%!!!


Happy investing!
Source:Valueinvestor.com