Special 300th Episode: Unlock Wealth Creation with Mutual Funds!

I thank you for being here, and I will just set the context. What are we going to talk about? How mutual funds come into play, and why it is not only critical but inevitable. If you don't invest, you're losing time.

As you all are relatively young, I'll not scare you. Let me list down four or five things because we don't really think of money in that context.

One is that the most dangerous myth is that playing it safe will take care of it because, in all other dimensions of life, playing it safe will take care of it. You work hard, you earn, you spend and whatever you save, leave it in the bank. This is actually a very dangerous myth. This is a myth because this is a recipe for remaining poor all your life. If you work hard, your money also needs to work hard. Second, the moment you try to get venturesome about your money, all the roads to enhance the return on your investment are filled with all kinds of land mines.

Suggested read: Time, pragmatism and pessimism

Most of the time, by remaining safe, you are basically losing on time. And for your investments to grow productively and become rewarding, time is the most crucial thing. You need time on hand for the investments to work to their full potential. Then, only the magic of compounding gets triggered. And the earlier you start, the better.

Suggested read: The power of compounding

Many youngsters who should start don't, because they are freshers. The first time you get a job and become financially independent, you have the liberty and freedom to spend however you want. And at this age, you'll have many desires but limited resources. The initial phase is crucial as you will have enough time to build sizable wealth.

The first year of earning is the habit formation part. If you start with Rs 500 a month, the magic is not that it is a sizable amount. Instead, you'd have accumulated Rs 6,000 by the end of the year. And if it grows, you'd understand that the money has grown for free. You so far haven't gotten any money for free. This is where the magic happens; you convert a small sum into Rs 6,000 a year. So whether it is Rs 500 becoming Rs 6,000 a year or Rs 1,000 becoming Rs 12,000 a year, it doesn't matter. This has more to do with habit formation.

Suggested read: Tiny habits for big results

You all haven't experienced inflation in its true sense, but you might have heard stories. You'd have heard, "Back in our day, milk used to cost so little. And ghee used to be cheap." Well, that's inflation, because of which some of the big ticket things we want to do in our life have gone out of hand. For you to be really on top of things, you have to understand the impact of inflation on your wealth. You may leave it in a bank and feel it has grown a bit. Whereas, in reality, its value has actually gone down.

It is actually a very dangerous thing. While compounding may be a wealth creator, inflation is the opposite, a wealth destroyer. And it can be devastating for some people. Just earning, saving and keeping it aside is not good enough. You need to invest in equity, and that too for the long run.

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What typically happens is whether you invest in stocks, or whether you invest in an equity mutual fund, the promise is that they will offer inflation-beating returns. The reason for this lies in the way a company functions. Whether any company provides any money, produces some goods or a service for a company to survive and more so thrive. It must be an economically viable activity. It must be able to do things because all the inputs to a company providing a service or manufacturing goods must be adjusted for inflation.

Think of a Maruti car. In 1984, this company was launched, and it started producing cars. And this car used to cost Rs 45,000. But over a period of time, that same Maruti 800 has transformed into Maruti Alto. And now it costs around Rs 3.5 lakh rupees. The price has grown from Rs 45,000 to Rs 3.5 lakh rupees in 40 years.

If you took the price of a Maruti car in 1984 and adjust it for inflation, the cost would still be a third of the present cost. Which means they are able to deliver you a superior product at a lower price, adjusted for inflation. As wages go up, input costs go up, and steel prices go up, a company needs to account for inflation when pricing its products. And for a business to be viable, it must be doing it in an economically viable way, which means that the prices must be inflation-adjusted.

Suggested read: Equity without fear

If the business is able to make profits in line with the coming rates of inflation, you, as an owner, will be able to benefit from inflation-beating returns. That is the only promise. And so, equity is necessary if you want to beat inflation. However, the problem is that equity happens to be a volatile asset, simply because there are a lot of factors which cause price movements in the stock market. In the short run, the only way you can protect yourself is by having a long-term frame.

Then comes the theoretical thing called asset allocation. Asset allocation is when you diversify your money across multiple asset classes to reduce the risk element. You buy stocks, you buy bonds, or you buy an equity mutual fund, or you buy a debt fund, and you also buy some alternative asset. Or many people feel real estate adds an additional dimension to their investment.

Although asset allocation is crucial, but not at your stage. At least for the first three or four years, don't worry about asset allocation. But beyond that, once you have accumulated something meaningful as a result of your disciplined savings and are putting it to work, you'll need to take care of this as it provides insurance against a decline and helps you make use of a surge. And that is what gives you a very different kind of stability - a psychological one. Initially, you do not need to worry because you don't have much to lose.

Now, why mutual funds for wealth creation? Simple, for Rs 500, you can get a diversified portfolio through a mutual fund. Instead of buying a company that may die or make losses, invest in a mutual fund that can protect you against such inevitabilities because mutual funds give you direct exposure to dozens of companies. This reduces the risk factor.

Suggested read: Diversification: How to get it right

There's a saying that goes, "Death and taxes are inevitable." But when you hold a mutual fund, you aren't liable to pay any taxes until you sell it. And if you sell it after you retire, you will have no other income, just the gains on the mutual fund. That way, you could be exempt from paying taxes.

So, there could be great value in choosing a fund which you can hold for a lifetime because it will be completely tax-sheltered till you realise the gains.

This is where Value Research will come into play. Set up your portfolio on Value Research Online. Once you set it up, it will be able to alert you of your great investments and poor ones. It will help make it easier to clean up and reorganise your portfolio. While this is a continuous process, don't do it more than once a year. This way, you won't run up a large tax bill.

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Make sure that you know you are investing diligently. Also, for any money you'll need in one to three years, plan some liquidity for that. Don't depend on the market. And the rest of the time, keep accumulating your money and do your SIP. When you retire, take the money out from your investments, and you will get a tax-sheltered income that compounds at a higher rate. This is the simplest formula; don't complicate it.

If at all you get greedy because you think that you have got an excellent idea, make sure that you are validating that proof of concept, and then putting money in so that it does not derail your overall plan.

I am a young investor. I started very early. I have student loans to pay off, so I want to balance my investments with it. How can I go about doing it?

Look at your student loan repayment as an expense. And invest as much as you can beyond that. Otherwise, think of paying off your debt as an investment in your future.

When will I be ready for the stock market? Also, if I am, should I sell 60 per cent of my mutual holdings to invest in stocks?

It entirely depends. Nobody can tell you when you are ready for the stock market. And you will also not know when you are ready for the stock market. It is how you behave when you are faced with a big decline. Your preparedness for the stock market is tested not in good times but in extreme times. It is tested with your patience, with your diligence, with your understanding.

When it comes to transferring your mutual fund investments, it is not a matter of 5 or 60 per cent. Instead, it is prudent to decide your method, asset class, purpose, and time horizon. If you are holding for the long term, then you can put, say, 25 per cent in stocks. In two to three years, you'll understand how your stock money has grown compared to the mutual fund investments. This will give you a categorical winner.

Then, you can be objective about it. That said, I wouldn't say drop your stock investing aspiration as it is a promising thing. If you have the time, if you have the inclination and if you have the temperament, then pursue it. After all, more than financial analysis, more than the foresight to spot a company, it is your own discipline and temperament which will determine your success in the stock market.

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I have two, three, or maybe four long-term goals. So should I do an SIP for every goal?

You don't need to have four SIPs for your goal. If you are able to spot one good fund for those goals, that is good enough. Make sure that the fund is good enough for some of those goals. There could be a goal you need money for in five years. There could be a goal for which you need the money after 25 years. You have to save enough money for those respective goals and let your investments grow.

Suggested read: How should you divide your savings across different goals?

When should we stop investing? Or even pause it?

You should never pause investing. When you have reached your goal and need the money, you should take your money out. And if the investment is not doing well, move your money and invest in something else. Later, you should actually do your asset allocation and de-risk yourself once the sum has become large and meaningful. These are the only reasons.

Simply taking out your money only because it has gone up is not a good strategy.

Suggested read: Real, practical asset allocation

If we invest at a younger age, it's not considered very cool among others. How can we deal with this?

Don't tell your friends that you are investing.

What will be the basic advice you will give to someone who just started investing?

There is nothing in investing which can be learned from others. You have to experience it because everybody's context is different. You have to lose your own money to actually formulate the plan for what happens. So find a fund where you can do a Rs 500 SIP and just start it.

It's important to have an emergency fund and a separate corpus for our goals. But when we consider taxation, we generally go for ELSS funds that have a lock-in period. So, how should we carve out money for short-term goals?
You should know your short-term goals. If you have money you need within three years, then invest it in something very conservative. Even if you are not investing in a mutual fund and are keeping that money in a bank account, the money you need will still earn some interest of, say, 3.5 per cent in a year. And if you put the money in a very successful short-term debt fund, it will earn you 6.5 to 7 per cent. It will not make much of a difference in the short run.

But for your long-term investments, not investing in equity, and earning 6 to 8 per cent and not earning that 15 to 16 per cent over a long period of time is a huge deprivation. Today, I would say that people should not worry about emergencies. People definitely should worry about their short-term goals and invest accordingly.

Suggested read: Equity mutual funds for long-term goals

How to choose a good fund?

My starting point is to choose a diversified fund. And there are five categories of funds which are diversified. These include large and mid-cap funds, multi-cap funds, flexi-cap funds, value funds and tax-saving funds (ELSS funds).

I'll go to Value Research Online and choose these five categories. Then, I will check our ratings for the funds. It is a scale of risk-adjusted performance to determine which is a good fund.

A good equity fund is one which rises well when the market goes up and falls a little less when the market falls down. And that is how, over a period of time, you make a little more money than the market. With an index fund, you get exactly as much, no more, no less, just the expense. So, our risk-adjusted rating is basically a reflection of this. A fund that follows the principle of falling less in a bearish market and rising well in a bullish market will be a four- or five-star fund.

I will not hold a sectoral fund, thematic fund, small-cap fund, or mid-cap fund. While these funds have periods of extraordinary performance, they have extended slumps too.

On the other hand, by having a diversified fund, you are actually buying the full market. In other words, the fund manager has the flexibility of investing all over the market to pick out stocks with the highest potential.

Once I shortlist in this manner, I'll have 15 to 20 funds. Then, I'll pick out funds that were launched over seven years ago.

Then, I'll look at the changes in fund managers. If I notice a fund with a four or five-star rating but the fund manager has changed, I'll not be able to attribute the performance to the one in their place. Then, I'll search for the fund that has done the best in a rising market and has fallen the least in a falling market.

Lastly, I'll check the long-term performance of, say, 5 to 10 years. And I'll choose a fund or two.

Suggested read: How to choose a mutual fund

Are passive funds a good choice?

If you can't choose an active fund, invest in a passive fund. They will get you 80 per cent of the benefits of investing in equity. However, there is a possibility that in some time periods, active funds will not be able to outperform the index.

Our goal is to spot a fund that will do better than the index in a five to seven-year time frame. A fund that does well in a rising market and falls less in a falling market will beat the index. If you choose an index fund, just look at the expense. The lower the expense, the better the performance, or the closer it matches the index returns.

Suggested read: The time to be passive is coming

What should be our investment strategies when investing for the short-term or medium-term?

Choose a fund and keep investing. When you need the money, start pulling out the money well beforehand.

Suggested read: When to sell a fund

Whom should we trust with our money?

For financial advice, the best thing is to learn a little bit. And the second best option is to keep looking for financial advice. The profession hasn't evolved much. One needs to really understand the context of your investment journey. If you are investing Rs 500 or even Rs 10,000, no one will show interest.

This is because managing this amount won't be an economically viable activity for them. Once your investment sum becomes substantial, relationship managers will flock to you. After all, they'll get a big commission from the investments you make. That is when you should ask them a series of questions as if you are hiring someone. Remember, this is tricky because an advisor may be a wolf dressed in sheep's clothing. After all, they may just be an investment salesman.

Suggested read: The culture of commissions and why it's a problem

When investing in a fund, how important is a fund manager? Also, what should you do when the fund manager changes?

The fund manager is the most important person or variable in the whole fund's performance. And if the fund manager changes, you should get alerted. But many times, a change in fund managers is for the better. I will give you an example. Recently, a fund was launched, and normally, at Value Research, our whole hypothesis is that you never invest in a fund without a track record. But here was a fund manager who came with an excellent track record of 30 years.

He did so well that when we look at his long-term performance, even now, because of those periods, it actually stacks up at the top. I was very excited and tempted to invest, and it has actually turned out to be true. But remember, great fund managers have lean periods. And not-so-good fund managers can turn around as well. The real indicator is to look at how many funds beat the index in 10 to 20 years.

Many influencers promote investing through SIP or putting money in stocks, while our parents still recommend real estate, etc. Today, the younger generation is going for IPOs, derivatives trading, etc. So, what do you suggest is the right investment path? And if you refer to mutual funds or stocks, then is it possible to buy a house through either of them?

I'm not very averse to people trying out things because the biggest learning comes from doing things.

I would like most people in the next one to three years to dabble in stocks. Do some trading, do some speculation, buy some crypto, and lose that money. Do all this because it is a part of learning, but don't let the lessons go to waste. In the process, develop a framework.

Now my framework for buying a house is that if you are going to live in that house, by all means, buy it. If you are going to invest in a house, expecting that the price will go up, never buy that house.

Never buy that house for a simple reason. It's a very big-ticket purchase. It is not liquid. And when you go to buy a house from an investment point of view, the real estate developer will push it saying that it is the last piece. And when you go to sell yourselves, you will find that there are no buyers, so you will not be able to sell. It is a very illiquid thing. It is a very big-ticket purchase. And borrowing for such a long time will leave you with a liability rather than a meaningful asset.

If you are going to live in that house, that might be worthwhile, and you will have the pleasure of owning a house. Now, how much should you borrow to buy the house?

When it comes to a house, people get very emotional. But be a little realistic about it. Make sure that 30 to 35 per cent of your income is not going towards your EMI, which means you have to actually scale down your house purchase. Second is that you wait so that you can pay the downpayment to the extent that EMIs don't make up more than 35 per cent of your income. And the third thing is ensuring that you are going to start living in that house so that you can start saving on the house rent immediately.

Suggested read: The EMI that comes back

How do you decide allocation between large-cap, mid-cap, and small-cap stocks?

Don't bother about large cap, mid cap, small cap. Instead, look for great companies.

Where should I invest?

Since you are in your 20s, you can start with a small-cap fund or an index fund. You may start with a multi-cap fund, too.

However, if it were someone who doesn't know much about investing and for them parting with any money is challenging, I'd suggest an aggressive hybrid fund. After two to three years, when they get a better understanding of the market behaviour, I'd shift them to a multi-cap fund.

Also read: Value Research exclusive: First-ever multi-cap fund ratings revealed

This article was originally published on November 15, 2024.