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Opinion

How To Buy A Mutual Fund (Ep-14)

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“Mutual funds Sahi hai doesn’t means equity mutual fund sahi hai… In the last 10 years, an SIP in a liquid fund has given exactly as much as an SIP in the nifty itself and even many mutual funds. So there is no hard universal thing you have to be in equity”

We often hear that “Mutual Funds Sahi Hai”. But none of the experts answer, “Konsa Mutual Fund Sahi Hai?”

Host Deepak Shenoy (CEO) and Aditya Jaiswal (Analyst) bring you another Podcast where they simplify mutual funds, allocation (debt-equity), SIP vs lump sum debate, the myth regarding Star ratings, ELSS funds, expense ratios, Sectoral funds and a lot more!

Transcript:

Deepak: Hi and welcome to another edition of the Capitalmind Podcast. This one is going to be interesting. Last time we talked about houses. This time we’re going to talk about another element that’s doing the rounds. Because people are buying mutual funds. And then, now there’s so many things too that we’ve heard from people that. The most basic question that we want to answer right now is how do you buy a mutual fund?

I mean just as simple as that. Aditya has got a bunch of questions for me. And what I will tell you in my own little way about how I think of the mutual fund buying process and perhaps as a person who might be entering into this field yourself. A person who’s experienced you might find some valuable insights from this. Again, welcome to the Capitalmind Podcast. And hi Aditya.

Aditya: Hi Deepak. It’s amazing to be here, especially after the housing podcast. So I just want to start with a very simple question. Deepak why is life so complicated? Why is it so difficult to buy a mutual fund? There are 40 mutual fund companies. Each has a lot of funds. Each fund has a dividend and growth option. And each option has a direct and regular plan. So why is life so complicated?

Deepak: That’s a brilliant question. In fact, I think a lot of these plans, options, direct all this stuff is actually a consequence of the industry tripping on its own shoelaces, right? So because you start off at something, you said. There are so many stocks. How will we select between all those stocks? There are so many other things. How will we select? So let’s make a mutual fund.

Somebody, some fund managers as a smart enough guy. He’ll go and figure out which stock to buy. He will buy 10 stocks, he we will buy 100 stocks and listen to his philosophy. I will go and invest my money with him. And we are done. But now there are 400 mutual fund managers. And you’re like, okay, everyone has a philosophy. I don’t have the time. To keep going through all those philosophies. And then within the philosophy you will have to understand it will tell me dividends or growth or dividends or investments or bonus.

There are four options actually. And nobody knows about them because everybody’s like, “What do I do?” Okay, then if I choose that, okay I have understood that. You know this is actually the… There’s an ad about this or this. I think this is a part of a movie that this person goes to this counter and says, “I’ll have a cup of coffee.” And he says, “Black or with cream?” She says, “Okay black.” Okay, but did you want it low form or something else? And then do you want sugar or do you want this? Do you want hazelnut?

“A 1% more investment is much greater than 1% more return. It’s like you are giving yourself a 1% more return by just adding Rs 200 more to a Rs 20,000 monthly saving. I will actually make more money in the longterm, rather than by trying to get 1% more return by selecting multi-cap, large-cap, small cap- you can go mad!”

But at that time you are like I just want a cup of coffee. Just get me a cup of coffee. So it’s like, give me a mutual fund. I mean whatever you guys want. So it’s complicated because the industry makes it so. Because there is some fringe element who says, “I want a mutual fund that I want dividend every month, not every quarter and therefore I want an option that tells me there’s a monthly dividend option. And I want a regular or a direct plan because regular plans involve paying somebody commission.” Let me simplify all of this for you okay. Simply forget about dividend options.

Aditya: Okay.

Deepak: Simply forget about regular or growth is if you’re listening to this mutual fund. You want to buy a mutual fund. So you’re going to go to the direct option. That’s it. If you want to go to the regular option. Don’t listen to this podcast, go find an advisor. He will buy your regular mutual fund. He will explain all these things to you. That’s his job and he gets paid for this process.

We will explain now only direct growth options of mutual funds. Regular growth once you’ve got that then you got to figure out now between. “Oh, I want large-cap, mid cap, small-cap, this cap, that cap and all that stuff.” And that is just the equity portion. There’s a whole lot of things around the debt portion of a mutual fund. The debt component of a mutual fund is simply… Or the debt component of mutual fund is simply this.

A mutual fund isn’t supposed to invest only in equity. Mutual funds Sahi ha doesn’t means equity mutual fund sahi ha. It just means that you’re going to use a vehicle to invest in something. You could actually pool in money if it was possible to invest in a house. If it was possible, it’s not possible right now because there’s no easy vehicle to do so. But mutual funds can invest in stocks. They can invest in bonds. Bonds are like fixed deposits. Stocks are like you know stocks they are risky. Both have a different level of risk. You choose a mutual fund as a vehicle to invest in whatever you want to invest in. Because you don’t have the expertise in investing in those things yourself.

Now what we will go through is perhaps a concept of saying these mutual funds or the 4,000 whatever mutual funds. Different mutual funds, if you take all the options direct, dividend, together.

Aditya: So despite this being so complicated. Say I want to invest, I want to invest in a particular mutual fund. Help me find one. I even don’t know what should be my allocation? Equity- debt, 50-50 or 60,-60.

Deepak:  Yeah. So I think the point comes as don’t go trying to buy a mutual fund. Okay, you’ve got some money, you’ve got some savings, you’ve got some investment which you’ve already done.

Aditya:  Okay.

Deepak: Then put that together somewhere and say,” Yeah, this is where I am right now I have money in the bank. I have a PF.” PF is basically like debt. It’s not going to be risky for you. It’s going to be an investment something relatively safe. So you consider that like a debt investment. Which is a separate allocation and then you say, “Okay totally I have say five lakh rupees, one lakh rupee or 10000 rupees.” It doesn’t matter what you have but you to figure out what you have in the first place.

“If you buy 4 large-cap funds, put together, you own the index. So you are paying a higher management fee to own the index!”

Now when you have that, you say, “Okay, going forward, I am comfortable with how much risk?” Now if you had a financial advisor you might actually nail down your goals longterm, retirement, kids education all that stuff. It will be a more detailed thing. We do this at Capitalmind Wealth. But just as you have nothing, you are like, “Okay listen, I don’t want a lot. I just want something, you know.” Okay let me tell you this. First find where you can take risk. I am saying if you have 10 lakh rupees, don’t go around investing 5,000 rupees in an equity fund.

Because mutual funds sahi ha. Because that 5,000 rupees will do nothing to your life. You need to figure out how much of my total amount I have, should I have in equity and should have in debt. So thinking longterm or thinking at least 10 years, 15 years from now. And you’re saying here, “I’m the longterm I would rather be risk averse.” Risk averse in a sense totally risk averse would be 0% equity. Don’t do equity at all. Just do debt. You can do debt through fixed deposits- very tax inefficient.

You can do debt through debt mutual funds- better. But has a small amount of risk. If you’re really risk averse just go by liquid funds. Those large liquid funds, like currently it’s HDFC and ICICI it will be something else tomorrow. But it’s basically those extremely large liquid funds. They will give you a nice return, possibly better than a fixed deposit in the long term. I personally got more than 8% returns in the last five years in liquid funds. But your mileage will not be the same. You will not get the same kind of return because rates are lower now. But that’s the safest.

Just buy it and keep it and don’t worry about it. Now, if you’re saying, “Okay, I want to take a little bit of this.” you will say, “Okay out of my 10 lakh rupees I want two lakh rupees in equity and eight lakh rupees to debt.” This can be 10000, it doesn’t matter. But I’m okay with only 20% equity. Now whatever I mean by 20% equity? It means if my equity falls by half also, if out of 100 rupees I put 20 rupees in equity, I will lose 10 rupees, right?

Aditya: True.

Deepak: But in that remaining 80 rupees, I will make some money out of debt. So one or two years I will recover that 10 rupees. So essentially in two years I will go back to being where I was. Which is actually not too bad because I won’t lose any capital in two years. So roughly its is safe to say that I’m okay I’m within two years I will recover my money even if the market fell by half. And all probability the market may go up. So it will give me a little bit of an upside, but it won’t give me a huge upside. So 100 will become 110 in a year maybe 111. But not 140, 150 so I trade off the risk versus the reward, and I say, “Okay, I don’t want to lose too much, so I will not take too much risk.”

So 20% equity, 80% that’s fine. Once you’ve decided that, that’s great. And you can say, “Okay, I want to decide what my equity allocation should be.” So my equity allocation should be 70% then. And from saving 20,000 rupees a month then I should put 14,000 rupees in debt and 6000 rupees sorry, 14,000 rupees in equities and 6000 rupees in debt. That’s my sort of thing. And also find out where you need to be. And how much debt. People will say and how do I decide between 65% and 70% ? You know what there’s no such thing.

Actually you say, “Okay, either I’m 20% equity or I’m 80% equity.” Just about that anything in the middle is a trade off. And if you can’t decide just choose, 50/50. Put 50% in stocks 50% in debt. In the last 10 years in a SIP in a liquid fund has given exactly as much as an SIP in the nifty itself and many mutual funds.

Aditya: Wow, amazing.

Deepak: So effectively debt is not worse than equity. Debt can be better than equity and equity can be better than debt. If you don’t know what to do. Just put half and half in both and you are done. So it’s not rocket science to put in both, there are periods of at least 10-15 years. Where even SIPs in mutual funds have returned less than the equivalent investment in the bond market. So, which means in debt funds. So there is no hard universal thing you have to be in equity.

But you choose now you say, “Now I know how much money to put into equity funds.” Part of that can be amount I have already saved. Which is currently sitting with me as cash. And I say, “Okay listen I’ve already got so much money in an FD that is debt. Some money in PPF some money in PF some money in some LIC policy. All these constitute some layer of debt. But I want now put a certain amount lumpsum into equity. And then every month I will to put some more money into equity and some more money into debt.” So it’s like a choice I may have a planning level. Now once I have planned. The next stage is where I think people are going to need a lot more help. To decide how much money I want to put into an equity fund now what do I do?

Aditya: True. So suppose as you said, I do 50/ 50. But when we talk about equity mutual funds. Again there are a lot of complications like for an investor who wants to invest in equity mutual funds. How should one decide the allocation between large- caps, mid-caps, small-caps and multi-caps? Now recently, as you know, SEBI classified mid-caps as the highest market cap companies from 100 to 250. So basically the mid-cap companies have drastically reduced to just 150 odd companies. So if I’m not wrong, isn’t this category going to lose their best performers over time? So all these complications may confuse retail investors. So how should one decide the allocation?

Deepak: You know this is where I think life has gotten complicated from a SEBI angle and also from the mutual funds themselves. Because they call their fund large-cap sometimes they have to because it’s the way the fund is. But here’s a thing, okay. The concept of a cap is simply the size of the company. If you sold all its shares.

Aditya: True.

Deepak: Amazon is a $1 trillion companies. So if you sold all the shares of Amazon. You will get $1 trillion. This is a hope in hell really. Because if you actually sold them. Let’s try to sell all the shares of Amazon. You wouldn’t even get $100 billion. Not even 10 because if you’re selling all the shares. Who will go buy? I means its just… It may not be useful company to sell. But the point over here is that if you sold all the shares of the company. What is the value of that company?

It’s almost like you valuing you house. If I value my house because some my neighbour bought his house 100. Well I will if I go to the market on the pay to sell. I might get a much different lower, higher some different rate. But to use his value as a benchmark. So every day when shares are bought and sold. The buying price or the last traded price of that stock is considered to be the value of that stock. And therefore total number of shares that the company has into that share price is equal to how much you can get. Reliance Industries today can get 800,000 crores if its sold. TCS can get something around that. HDFC, EMC can get only 75,000 crores. I say only, but it’s still a large number. And then you’ve got the much smaller numbers behind them. So you’ve got a BPCL at 50,000 you’ve got a Mannapuram at 18,000, Equitas small finance bank at 3000 and so on.

So now you classify these into market caps. So you say take the top 100 companies. And top 100 companies in India and at around 30,000 crores in market cap. That means the top companies 800000 crores. The 100 companies work you 30000 crores. I’ll only invest in those. Now of those… If you want to invest only in large cap companies. That means companies whose value is in the top 100 companies in India. They want to choose a large cap mutual fund where as we had said now this is as of last year. That you can only invest in companies, which are in the top 100 or rather out of your 100 rupees. If you have in the mutual fund 80 rupees has to go into these companies. 20 can go outside typically keep a little bit of cash. They’ll have some investments.

Where I’ve invested in BPCL last year, but now it has fallen to just below 30000 crores. So should I sell it or not? There’s a little bit of leeway that says if it just falls off the radar. Maybe you can continue to hold it. So it’s only 80% but that means that most of these mutual funds. On these mutual funds are restricted in what they can buy. So they can’t really decide that I will go and a bet a lot of money on a small company. Because if they do then they will violate the guidelines. So they’re all of the large cap measure funds are going to go and invest in the same 100 companies. With 80% of their capital. So this is one part that’s to understand. Now mid-cap has… listen I saw the top 100 but you know what the best companies are perhaps smaller than they started.

I wanted to be there in this start. So I will invest in a mid-cap mutual fund. Which says company’s number 101 to 250. These typically right now are about between 7000-30000 crores. So 7000 crores is the lowest end. 30000 crores are the highest end. That’s roughly the market cap range you’re talking about. So more than a billion dollars and less than maybe five, four and a half billion dollars. So that’s the kind of market cap we call mid-cap. There’s a lot of companies here. Well the growth may be spectacular because they’re relatively small. And they have a big runway to grow. But they also could be companies that were earlier large caps have become mid-caps. So you’re going to get the worst of the large-caps that come down to you. So the handout from the large caps will come to you.

Second you will also get fast growing companies like Bajaj Finance, which was a mid- cap at some point. It grew so fast that it became a large-cap. When it becomes a large-cap, a mid-cap mutual fund has to perhaps reconsider whether it can hold it or not. Know large-cap funds are required to put 80 rupees of every 100 into large-caps. Mid-cap funds the limit is 65 rupees out of every 100. Which means 35% of their assets can be held in other companies. So they get a little bit more leeway. So a mid-cap fund may be quite an interesting thing. To complicate matters there are large and mid-cap funds there are multi-cap funds there are small-cap funds there are sectorial-funds there are strategic and quantitative funds. So don’t ask why all these things exist, but they exist in.

So don’t confuse yourself in all of those. Simply I would say this for a beginner investor. If you’re starting off, just stick with large-cap funds. If you feel that they’re slightly more smart than large-cap guy. Go to 60% large-cap and 40% multi-cap. Multi-cap means the fund manager gets to decide whether you want to put money in large-cap or small-cap or mid-cap depending on his choice. This is great because that’s what you’re doing. You’re trusting the fund manager with his choice of funds. Now, he therefore gets a flexibility, you get the potentially higher return if he’s smart. So you could then therefore adjust to this. Now, if you’re going to be smart enough to say, “listen no, I want 20% mid-cap 3% small-cap, 4% large-cap.” And become a fund manager and go and buy all these stocks, why are you bothering giving money to mutual funds? It’s simple… Keep it as simple as possible as less funds as possible. One large-cap fund maximum two and one mid-cap fund or add the max too. So just keep it as simple as possible. And I think you will find that today for instance there’s been a good performance by say an access or PPAFs. Which give you a broad multi-cap exposure. When I’m talking about multi-cap funds both of them have a multi-cap fund. Luckily they can have only one multi-cap fund or multi-cap funds. Being that since you will get large exposure you want a fund that has at least 50 to 100 stocks. Some large some small, some medium some small some kind of background of the philosophy of the company.

And a PPAFs for instance, which is a mutual fund that is a relatively small has investments in non India as well. So they buy Google and I think Google and Facebook or some non-Indian stocks some fund stocks. So there is that flexibility also that they can use. To who might want to bet on that as a thing. If you don’t understand any of this forget it. Just choose a large-cap fund and stick with it. And we will talk about large-cap. So I think the best way to do with large-caps is simply buy an index fund that buys the top 100 Indian companies. That’s all.

Aditya: Okay.

Deepak:  The definition is it has a top 100 Indian companies at all times. In the proportion of the nifty zone. Nifty is top 50 there’s something called the next 50 nifty next 50. So you can buy some an index fund called the nifty 100 index fund, or just buy a nifty 50 index fund and a nifty next 50 index fund. Both of them don’t make a choice on what companies they can invest in. That choice is made by whoever creates the nifty 50. The nifty 50 creators also don’t choose they have a specific set of rules. Highest guy is number one next highest guy is number two next third highest guy is number three.

“But if I’m giving a star rating and you’re going to invest based on that star rating and you’re not paying me anything and I don’t care whether you lose money or not. What’s the value of that star rating?”

So they just put this and every six months they say, “Oh, this 49 fellow become 53.” Then make the guy who’s become the new 49 as part of the index on the other one has gone out to the index. So automatically the index fund will sell one and buy the other. And life is good. This simple combination has been some of the best performing mutual funds in the last five years. And in the west in the last 20 to 30 years they have shown consistently that they can beat most mutual funds.

Not saying that the mutual fund don’t have an edge. Some do obviously some will be on top but I am seeing one year one guys on top another year the same guy is not on top. He is probably somewhere in the middle and 3rd year he may be in the bottom and the 4th year he may come back on top. You don’t want to deal with all these complications. You just want to be, let’s say I don’t want the exact top mutual fund. But I want someone in the top 25% give me that. Large-cap go for indexes they are so much simpler. Don’t need to choose, very cheap. Nobody will sell them to you. That’s why I tell you to buy them. Because if you’re making those decisions choose what’s right for you and not for outside for your distributor.

Aditya:  Since you have talked about index funds. I also want to talk about expense ratio.

Deepak: So interestingly, the expense ratio is available on many sites. So now there are so many funds. How do you find all this information? Where’s the expense ratio- value research online.com search for a fund you’ll find it’s expense ratio. Typically there’ll be 1%, half percent. So the higher the expense ratio typically the worst fund should perform. But many funds in the past have done very well despite having high expense ratios because they are superior stock picking or some ability to earn more money. What you really care about is the consistency of its return profile over time.

Aditya: Okay.

Deepak: If the fund manager charges you or not it doesn’t matter. If he’s consistently in the top quartile. So if there are 30 funds in large-cap and out of those 30 funds. My fund is within the top five or six in the one year period in a three year period and a seven year period within a year. All you care about is that. So one year is not even relevant. Don’t even bother with one year returns. Okay so one year is such a lousy number to look at. Nobody should care.

Start with three years three, four, five, seven, 10. If a fund is consistently in the top. The 25% I’m not even saying the top one, two, three.

Aditya:  Just the top quartile.

Deepak:  If its rank is up to six out of 30 or seven out of 30. You should say, “Okay boss this is a decent performing fund.” And that’s how you kind of choose it. The expense ratio is already accounted for in the return. So you shouldn’t care. Now the reason there’s a difference in the two is because if you choose the regular funds, you will literally pay twice. In most cases the expense ratio and therefore the return profile will be much lower. Now, people do not compare regular versus direct a lot the same fund. Which invest in the same stocks in the same proportion can have a lower return if it’s a regular fund a higher return if its a non regular fund.

If you’re thinking of regular funds, then you should go meet a distributor who will help you understand all of these in much more detail. On a one to one basis and therefore you’ll be able to justify that you’re paying more. You know somebody’s spending their time explaining all of this to you. And on a one on one basis which even I will not do. Because it’ll take time and I cannot charge you if I do this in a direct mode. But because we know a lot of people listening to this the idea is justified. But if I do direct, that means I’m taking the responsibility and therefore I don’t have to pay someone commissions. So I want higher return. Instead of giving commissions away, give me those commissions effectively as returns in the fund. That’s what they’re saying.

There the expense ratio matters. So I wanted direct mutual fund to cost less than the regular mutual fund. Which will always almost always happen. And I also don’t want the expense ratio to be skewed in the favor of the fund manager. That it affects the returns. So if the returns are bad and the expense ratio is high. Then I think before even looking at the expense ratio. You should walk away from that fund saying that the solid returns are not good enough. So they evaluate things as just use returns and risk over a period of time, but don’t look at expensive ratios.

Aditya: So, another question that I wanted to ask is. Should one deploy the funds all at once or should one SIP? This actually reminds me of an incident that happened with me. So a friend of mine was calling me like a month or 45 days ago when the markets were falling. Every day he used to text me on WhatsApp that should I deploy the lump sum now? When the markets have bottomed out. Do you think the markets have bottomed? I just want to deploy the lump sum. So people actually try to time the market.

Deepak: In general. Timing a market is a skill, which means you should have enough knowledge about the markets to see there is a point where I don’t want to get in. If you possess that knowledge use it don’t stop yourself. After you do it once or twice and find out that you are good at it. Then you can continue with it. Put all your money in when you think the market is weak. I mean this is going to rise. Take all the money out when the market when the is going to fall. There are some problems and I’ll explain those. You buy a mutual fund and just think okay and buy it.

But you cant sell it when whenever you like. Some funds are locked in. Some funds have an exit load they will charge you 1% just to get out. If you get out within a year of purchase. So you don’t have to get out and get in and just ignoring all of this. You should know that getting out cost me 1% so I should get out. Some funds have no such exit load. Some funds will add an exit load after you’ve gotten in. So that exit load doesn’t apply to you it applies to any further investments that you do or if somebody else does.

But if this is the way exit load are designed. So an exit load will also tell you whether you should time or not. In the sense because if the timing is only a 1% of an half percent differential. Why would you bother? Because you’ll pay for the fund anyways. Now the other point about this is about whether you’re not good. Let’s say you do this for two, three times and say, “Damn, you know I got in and then the market fell.”

Aditya: Every time I was wrong suppose.

Deepak: Or every time or even 50% of the time because you don’t want to be wrong 50% of the time. Unless you are so good that you’re putting so much money in. That when you’re right, you make 5x the amount that you lose when you’re wrong. So, if you’re not good at it and you don’t have the time, don’t bother. The best way to calm yourself is to say, “That listen I’m investing on a 10 year period.” Instead of putting a lump sum, I will invest let’s say the same amount spread over six months rather than at one shot. Instead of saying, I’ll put 10 lakhs into the market today. I’ll say I will put two lakhs into the market today. I’ll wait for a month. And then in the next month I’ll put another two and then another two in the last two months maybe I’ll put one lakh.

So just spread the investment around and just to make you feel happier. If the market crashes in the middle just put more money so you will feel a lot better that way. Remember a lot of what investing is behaviour. It has nothing to do with the returns are better or not. We confuse ourselves in that conundrum. And I think you rightly put it. You’ve eliminated that question, but really many people with a 24% return can actually end up with a much lower number. Actual absolute amount than another person with 8% return. Why? Because the guy who invested 8% put five lakhs and the guy who invested 24% played around with 50,000 rupees.

Aditya: True.

Deepak: So he fought 24% but he ended up only with… Although he may have had the surplus. He just put that surplus into something or spent it, instead of investing it and then he’s left with a lot lesser. Simply because the person who invested say two lakhs or one lakh or just a 1% more investment is much greater than 1% more return. That means if I was investing 20000 rupees a month, if I just invested 20200 or 20,500 rupees. I will actually make more money in the longterm than getting a one% more on the investment return or a long period of time. Simply because of the way this stuff compounds. It will add up.

It’s like you are giving yourself a 1% more return by just adding 200 rupees more to a 20000 rupee monthly saving. Rather than by trying to get the 1% more by selecting multi-cap, large-cap and you can go mad. Like I did give you a sort of, the differential is 1%, 2% more than the selected the next index fund and be done with it. So it’s much easier to think of it that way.

Aditya: I know a lot of people invest in mutual funds solely because they want to get the tax benefits. So they invest in ELSS. But I see a lot of people investing in three, four ELSS funds. which I believe defeats the purpose because then a lot of stocks may overlap. So do you believe it’s a good strategy to over diversifying ELSS fund, say owning 4 ELSS funds?

Deepak: I think owning 4 funds have the same type of any type of mutual fund is a waste of time. If you buy four large-cap funds together, put together, you own the index.

Aditya: True, very true.

Deepak: So you are paying a higher management fee to own the index. What’s the point? ELSS is funds. ELSS funds are supposed to be tax saving now do you really need ELSS funds? If you have a PF of 10,000 rupees more or maybe 12,000 rupees or more. You don’t need an ELSS fund. Your PF at your workplace covers the tax benefits that are given to you. Second, if you have a child who’s going to school and you’re paying school fees. Those school fees are exempt under the same amount applicable for tax as ELSS funds. So if you have a kid going to school, don’t be Els don’t buy an ELSS fund.

If you’ve got PPF and you’re investing in PPF every year. Don’t buy any ELSS fund. You can take five year bank deposits and then also take ELSS fund. Because now your risk averse, ELSS as an equity fund. So don’t buy an ELSS fund. Insurance policies again you may need term insurance. You may be paying a certain amount of the 40000 rupees a year. You only need the remaining 110,000 to be invested in ELSS fund. So you don’t need to invest money in an ELSS fund. Just because somebody tells you it’s tax saving.

If the tax saving may not apply to you. You may already have had that tax saving and therefore don’t listen. Now within the ELSS fund you only do with one fund. You want to put money into it three years, one hour, one year after the other. If the ELSS has rules continue to apply. After three years your fund becomes free. As in it opens up after the 3rd year. So at the end of the 3rd year. So in the fourth year the first year’s investment becomes available to you. Redeem it and put it back. So at any point you will not try and put more money into an ELSS fund.

You just keep in reinvesting the same amount of money. There is a reason for this. Not because of anything else or not because… I just feel that there’s no need to lock in your money any other avenue. The same fund house a different fund may actually give you much better returns and give you liquidity. So you will be able to add more whenever you want. You will be able to take out money whenever you want. That flexibility is not available with an ELSS fund. So I would prefer… I would say keep the money. Keep it relatively less invested so you could do three with this. And having four, five funds is a waste.

Aditya: Actually this reminds me of… I met someone and… So there’s a lot of enthu right now. People are entering the mutual fund industry and people are doing SIP. So I met someone and I asked him, “How many mutual funds do you own?” So he said, “Four.” And then he said, “All are ELSS.” So I said, “Why?” So he said, “Because it’s tax savings. So the more I invest in ELSS the more tax I can save.” So this is the kind of knowledge that people have. They don’t know actually these things. And they believe that, “Okay, if I own five mutual funds, “5 ELSS kar dete ha, tax zyada save hoga”

Deepak: If that was a case. I will be recommending you do 500, over five years you can have 100.

Aditya: This is a true story this is not made up stuff.

Deepak: But actually in the end the mutual fund is going to go buy the same stocks. Whether it is this mutual fund or that mutual fund, which is ELSS. Is both of them. Most likely they will buy the same funds. Go check the portfolios out. You might find a significant overlap. Each one will have HDFC bank, which is there in every mutual fund. And then you will have a bunch of others and you’ll see the overlap. And you say, “Here to what is the difference? Why am I paying? Why am I breaking my head over which fund when they’re all the same.” And if they’re all the same just by one. It’s not necessary that a fund like this will outperform every year.

So choosing different funds, I understand that completely. So choose three different funds at max three after the third. Then rotate the first one on to the better performing one in the list that you have. So at anytime you shouldn’t have more than three. And to be honest you’ll never need it because your life cycle will take you through children, it will take you through… By the way a house principal, if you’re taking a housing loan even the house principal qualifies under the same bracket. So if you bought a house under a loan in all property, even that is contributing to the same tax thing. So you may buy only for three or four years and then stop. So just buy one or two funds at the max. Don’t push yourself. All the ELSS funds have the same philosophy.

So I don’t think you should bother doing anything else with them other than this. And honestly in any… Have three or four funds not more than that. Because you’re, talking two large-cap funds two multi-cap funds. That’s all you need.

Aditya: That’s it?

Deepak: In the equity portion. When it comes for debt, we’ll talk about debt in a different podcast. But it is complicated. You have short term liquid, ultra short term money market – sabzi bazaar.

Aditya: Credit risk.

Deepak: Yeah credit risk and a bunch of others. You don’t know, which one does that. There are also way simpler philosophy. Buy, get something that is something that is short term, something that is longer term that meets your philosophy of risk. Don’t push yourself into credit risk because somebody told you that it’s a good thing. But simply say that, “I want something that’s safe.” If you like that just go to PSU and banking debt funds. They will be volatile in the short term.

But over three or five year period they will actually do reasonably well and there is some risk of course. But at least you limited that to saying I try the government and not default on the PSUs. And so I will not lose my capital and banks will not go bust. Where so I won’t lose my capital. So I could live with that. And something that’s more short term or maybe liquid or ultra short term. Where I can access the money whenever I like. And it still gives me a return that’s better than a fixed deposit or a bank account when I am not using it. So that is the way… We will talk about debt in detail another time.

But keep the number of funds you have small. So, if you ended up having more than 10 mutual funds you’re doing something really wrong.

Aditya: Okay. Here comes the funny part. So, personally I believe that looking at star ratings is the dumbest possible way of picking mutual funds. But actually a lot of people do that.

Deepak: Yeah. The problem is the star ratings are given by human beings. For the most part the human beings sometimes don’t look at the fact that these funds are defaulted badly. You’ll find five star fund ratings in debt funds, which have given you a negative 10% return over the last one year.

Aditya: Wow.

Deepak: This is intolerable, but it’s happening. And why is it happening? Because the people who give the ratings are not accountable for the reason why the fund fell down. If I told you this is a great fund and I invested your money and I took a fee from you. I stand to lose my fees from you in subsequent years.

If that fund does really badly because you will say,” Deepak take my money out or I’ll move it away.” And then you will no longer pay me mini fees. Now this is a reason for me to try and perform. But if I’m giving a star and you’re going to fund on that star and you’re not paying me anything and I don’t care whether you lose money or not. What’s the value of that star? It has nothing. It has nothing to please anybody.

Aditya: True.

Deepak: It just gives you a feeling that somebody has a status like a star result in Google or in many times on Amazon. The number of stars in many times does not indicate the kind of quality you will get.

Aditya: True very true. This is a very good example.

Deepak: So it because of that, if you’re not going to trust them in food or in Amazon or in Google, then why would you trust them in with your money? I mean, your money is more valuable.

Aditya: So, okay, let’s talk about sectoral funds. A few people, a few investors believe that if they can’t take risks by investing in stocks directly. They can bet on sectoral mutual funds, to bet on these underlying sectors. I believe this is a very dangerous idea because on the contrary. I would say if you are really much into betting on sectors. Why don’t you go direct?

Why don’t you invest in the stocks rather than betting on sectoral mutual funds? Because I don’t have control on the exits. Suppose I buy a sectoral mutual fund and I come to know that the story’s not panning out the way I imagined. I may not be able to get out immediately. Rather than when I’m investing directly in say aviation companies. I invested in, say SpiceJet or Indigo and I certainly want to move out. I can do that whenever I want. So what is your view on sectoral mutual funds?

Deepak: So I think sectoral mutual funds are like iPhone and the Mac. Apple had this conference where it revealed the really fancy fantastic monitor.

Aditya: Okay.

Deepak: The monitor was expensive super expensive, I don’t know if $10-15000 or something like that. And then they said, this will do everything. You know you can do this, you can do that. And then they said there is a stand. The stand of the monitor is like $1000. Now everybody’s like. Why would you pay $1000 dollars for a stand? But you know, this was Apple and people got carried away with the hype and said, “You know what I own a stand worth $1000.”

Aditya: I want that stand itself.

Deepak: So it’s depends on a lot. It’s like you know what I’m going to be smart. Know I’m better than the rest. I know when Pharma is going to turn. So I won’t buy a Pharma for now. It’s fine. You know everybody needs this mental stimulation at some point. So go with a five lakh portfolio put a 1000 rupees on a sectoral fund it’s fine. Because even if you lose that 1000 number that wouldn’t change your life.

Aditya: You get to learn.

Deepak: So don’t do 50000 don’t do 10% of your portfolio in a sectoral fund, it’s complete nonsense. Keep money that is about 0.1, 2.5% of your portfolio for playing around and losing. Because every once in a while you’ll feel this itch to go and play with some new fan dangled toy and don’t hurt yourself in the process. Just keep a little bit of money and invest it. And then be very happy that 1000 rupees has became 2000 rupees and how smart you are. But you can be rest assured that all the other equity funds are also buying Pharma. So they would have also gone up because the fund went up and if the multi cap managers are smart.

They would have had more of that allocation. The indexes will automatically give them a higher weight when they start doing well. So those sectors will start doing… They will start having more and more into index who are index funds will also do well. So you will make money into… And to end and you’ll have something to write home about how well you chose your sectors. But don’t get carried away because if you’re really good, like you said, just go buy the underlying stocks and get out whenever you want. Get out of one instead of all five. Buy five or six or stocks in the sector and just stick with it.

So it’s just the way it is. Simplicity is better. So Keeping things simple is way better for you in your financial life, then it is to try and complicate yourself with. Whenever you find complexity find the simplest thing to invest.

Aditya: Okay.

Deepak: So it’s easier to invest in an index fund and nobody’s selling you that. Because not only is it easy, but because it’s less complex. When people make less commissions out of it. So nobody wants to sell you this stuff. Buy the index, buy the liquid fund because nobody wants to sell you the liquid fund. Because nobody makes commissions out of it. It’s just the simplest thing to invest in and it keeps your mind happy without having to take way too much risk.

Aditya: So a quick question Deepak, where can we buy these mutual funds? Like which websites or?

Deepak: There are hundreds. You can go to the websites of the mutual fund companies themselves and buy it. You may require a KYC if you haven’t got one. They will, some of them will help you. There are other websites. There are websites like Paytm money there is websites like ET money. There’s websites like Grow grow and there is a Zerodha and a bunch of others. There is also cams online cams is one of the RTAs and it allows you to buy relatively easily. So you can go to any of these funds and buy Paytm and ET money might actually have an easier interface to do KYC and therefore get your investment in faster.

But once you’ve run the KYC you can buy in any of these places. And other than the Zerodha where you have to buy in Zerodha and sell in Zerodha. But if you buy in one of these sites, you can actually go to the mutual funds own website and then sell from the mutual funds on the website as well. So it’s inter operable so you can actually buy from one and sell from the mutual funds own website directly and they will not be a problem. What is good about it is the regulations don’t allow any of these intermediaries to take your money and keep them.

other than Zerodha where the money is again kept in a regulated account. So you don’t actually transact with these players you are put directly with the mutual fund houses. And that is how your funds are kept safe from people trying to be deceived. Remember when you redeem those funds and you sell the funds, you will get the money directly into your bank account. It won’t go to any of these players. The Paytm money it will not go. It will come straight to your bank account. So you will never have to worry about these portals going bust not making money. Your funds are safe no matter where you invest if from.

Aditya: Okay. So I think we heard an amazing discussion and thanks a lot for answering my questions and I hope our listeners like the podcast.

Deepak: Lovely. It’s been great Aditya and thanks again. And all of you thanks for listening. Please connect with us at capitalmind_in on Twitter. I am at deepakshenoy on Twitter, Aditya is at astuteaditya on Twitter and you can connect with us. Tell us what you think. Ask us your questions on mutual finance. Visit capitamind.in. we have a bunch of articles there that are free. Some are premium so please consider subscribing to some of the premium articles as well and we can help you. Our Slack channels we have a bonds and funds channel where we discuss funds all the time.

Deepak: And of course we have Capitalmind wealth as well, which is a portfolio management services. Where we will actually deploy your money into stocks and mutual funds or only mutual funds if you choose that to be. And we can help you with the investing process as well. That’s me advertising everything that we have. I don’t know how great I am. This is children’s day here. I know you’ll probably hear it a few days later. But just being a child keeping it simple and enjoying the rest of the day.

Aditya: Thanks a lot, Deepak.

“Keeping things simple is way better for you in your financial life. Whenever you find complexity, find the simplest thing to invest. Buy the index, buy the liquid fund because nobody wants to sell you these. Because nobody makes commissions out of it”

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