MF Myth Busting

Their net AUM (Assets Under Management) may be close to the Rs 18-lakh crore (18 trillion)  mark, but an astonishing number of seemingly simple, and yet potentially damaging fallacious beliefs about mutual funds as an investment vehicle seem to withstand the test of time. In this series, we explore - and debunk - them, three at a time.

Ratings as the "sine qua non" of fund selection
Nowadays, the act of evaluating and selecting a mutual fund scheme seems to, for most people, involve nothing more than a google search. And but naturally, the first few pages that pop up involve bright yellow stars - or the lack of them. Unfortunately, this is where the quest for selecting a great fund ends for most individual investors. However, it's important to know that a high star rating will not guarantee future outperformance, and vice versa. Ratings methodologies, for one, are more retrospective than forward looking. They also do not very well consider longer term alpha generation strategies such as deep value unlocking. Also, worth noting is the fact that even a highly-rated fund may not be coordinated with your own risk profile. Do not make ratings the core of your fund selection strategy.

MIP's guarantee a monthly income
MIP's or "Monthly Income Plans" are thought by many to be a bullet-proof mechanism for generating a guaranteed monthly income stream. Some even believe that the quantum of this monthly income is guaranteed. However, the truth is that income from MIP's is neither guaranteed nor assured, despite their seemingly misguiding name. MIP's are in effect a hybrid, debt oriented mutual fund that takes an exposure to the tune of approximately 10-20 percent to the equity markets. You can choose between the growth and dividend (monthly, quarterly or half yearly) options for the scheme. The fund could, based on its performance, decide to declare a certain dividend as "rupees per unit" - this will come into your account after a deduction of 28.33% (dividend distribution taxes). If markets head south (debt, equity or both), you could have a situation where MIP dividends dwindle to insignificant proportions or stop altogether, depending on the fund houses strategy. Some MIP's may choose to continue paying dividends through bearing markets, but do keep in mind that this is not classically an "income", but part of your principal - as your actual fund value will keep diminishing thus.

A SIP of Rs. 1,000 per month will make you a 'crorepati' someday
Well - it could, on paper, in about 40 years' time. But this is really a fallacious belief for many reasons, regardless of what those fancy cardboard "wheel style" calculators may have told you. First, in 40 years, the purchasing power of Rs. 1 crore will be the equivalent of Rs. 10 lakhs in today's terms, so accumulating the said amount itself won't be a reason for celebration. Secondly, you probably won't succeed in your herculean endeavor of keeping the SIP running ceaselessly for 40 years, unless you hibernate for four decades. Here's why: even after 20 years, you'll have accumulated around 10 lakhs; 20 lakhs after 25 years. The liquidity offered by mutual funds, coupled with your own frustration, will likely see the corpus liquidated several times in the 40-year period. In other words, you just won't make it to the last, high growth, high compounding 15-year phase which will see your fund value soar five times from 20 lakhs to 1 crore. If a crore is your target, think more like Rs. 20,000 per month for 15 years. The finish line will be closer, and 1 crore will still be reasonably valuable 15 years hence.