DO
NOT BE MISLED BY FALSE IMPRESSIONS ABOUT MUTUAL FUNDS
by Mr. Dhirendra Kumar, Valueresearchonline.com
The
basic terminology of mutual funds is needlessly confusing, even
misleading. Terms like NAV and dividend do not actually mean what a
new investor would assume they mean.
This is an unfortunate reality,
one which is not going to change anytime soon.
Therefore, it's best
for investors to make a little effort to understand what's going on,
rather than making bad decisions later.
Practically
speaking, the first thing that a new investor learns about funds is
that you buy a fund in `units' and the price of each unit is called
the NAV.
This is the first pitfall. While buying anything else, from
shoes to cars, we always prefer lower prices.
You are thus primed to
accept the idea that a fund with a lower NAV is better because it's
cheaper.
It's possible--even likely--that the fund is being sold to
you by a salesman who is actively pitching the lower NAV as a reason
for you to buy the fund.
This
idea is wrong. High or low fund NAV is a completely irrelevant
characteristic. There's no reason to decide whether or not to invest
in a fund based on it. In fact, this idea is so thoroughly wrong that
it can serve as a good indicator to identify a fund salesperson or
`adviser' who is deliberately misleading you.
Keep this in mind:
anyone who is asking you to choose a fund simply because it has a low
NAV is misguiding you. There are no exceptions to this rule.
What
really matters is what a mutual fund invests in and how the fund
manager runs it. A fund with an NAV of Rs. 10, and another with an NAV
of Rs. 100 will generate the same returns if their portfolios are the
same. The actual NAV and number of units you own are irrelevant. If a
fund gains 20%, the Rs. 1 lakh you invested in it is going to grow to Rs. 1.2 lakh. This could be 10,000 units at an NAV of Rs. 12, or 100 units
at an NAV of Rs. 1,200, it makes no difference.
The only use of the NAV
of a mutual fund is to compare it to its own earlier NAV.
This is how
the returns generated by a fund are calculated. Comparing the NAV of
one fund to another is not only useless, it can actually lead you to
make random investing decisions.
Then
there are dividends. The problem with mutual fund dividends is that
they are not dividends at all. To the investor, the term `dividend'
evokes the idea of corporate dividends, which are indicative of the
profitability of a company, as well as a measure of how much of the
profits are being distributed to shareholders.
Mutual funds
dividends, however, are nothing of the sort. They are just a
withdrawal from your account.
If the value of your investment in a
mutual fund is Rs. 1 lakh, and the fund gives you dividends of Rs. 5,000,
the value of that investment will be reduced to `95,000. There is no
additional benefit at all.
Getting a mutual fund dividend just means
some of the money, which was yours anyway, was withdrawn and given to
you. All mutual fund schemes have dividend options and non-dividend
options.
The dividend plan is convenient if you would like to
withdraw money from the fund regularly. You don't get anything extra
if you opt for it.
Just
like low NAV, if someone tries to sell you a fund with the lure that
it pays a lot of dividends, you can be sure that the salesperson is
trying to misguide you. Avoid such people at all costs.
What
is unfortunate is that both of these misconceptions are widespread,
and yet the socalled investor education efforts of the fund industry
never actively try to dispel them. Is this because using these
misleading ideas are a good way to sell dud funds which have nothing
else going for them? I suspect it is.
From ET
About the author
by Mr. Dhirendra Kumar, Valueresearchonline.com
Founder and Chief Executive, Value Research
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