May 2, 2007

Why invest in mutual funds if you can pick stocks

I got the following comment on my previous post and thought of putting my response to it in a post as I think it would help in putting my approach and thoughts on mutual fund investing in perspective.

"Low risk, low gain" is fundamental philosophy found true in every walk of life. I am surprised Why people like you, who can take risk after calculated move on the stock market, purchase mutual fund by paying hefty fee to suited gentlemen who musroom on CNBC and other TV channel giving alwyas buy advice in the time of Market going up and up? Find them when the market goes down......They will vanish.
Its my feeling that Mutual Fund is for those gullible masses who wants return on their capital but have no knowledge of stock market .Not like people like you, because why take risk on somebody feeling when you can take for yourself? That too by paying astronomical fee .

I do not agree with the above comment in entirety. True, there are several mutual funds which end up serving the asset management companies and their managers. A lot of these guys are just airheads who come on CNBC and other channels and spout useless drivel. Frankly I rarely watch these channels, they are at best a distraction and noise and just a form of entertainment. However, I would not sweep all the mutual funds with the same brush.

I consider mutual funds to be an important component of my portfolio in addition to stocks and other forms of investments. The reasons are as follows

- Low cost mutual funds with a good, consistent history are a good way of investing in the market and getting above market returns (the low cost and consistent history part is crucial). By selecting a mutual funds based on specific criteria (which I will post shortly), I can try to avoid the type of risks mentioned in the comment above.

- Mutual funds serve as a good benchmark for my portfolio. If my equity portfolio (stocks only) does not beat my mutual fund portfolio (net returns), then I am better off putting my money in well chosen mutual funds and not wasting time in picking stocks myself. In the end, investing is about the risk taken and the returns I get for it. I don’t define risk as volatility or loss of capital alone. Time spent on picking stock is also an investment for me and I see no reason to invest in stocks myself if my equity portfolio does not beat my mutual fund portfolio

- Mutual funds and ETF’s are also a quicker way of getting decent returns. I may not get the same returns as I would by picking stocks on my own, but I also end up spending considerably less time. This I say from experience.

I do not look at stock versus mutual fund investing. On the contrary for me it is stock and mutual fund investing.
Stock investing may give me higher returns, however I have to spend considerably more time on it. For every 10 stocks I analyse, I end up buying 1-2 stocks at best. Mutual funds may provide me lower returns, but I also end up spending much lesser time in selecting and tracking them on a regular basis. So in the end the returns I get compare fairly with the time and effort I spent on it. Investing for me is still a part time thing and not a profession (yet)


KM said...

Great post Rohit... I guess mutual fund provides two things which direct investing in stocks can not:

a) Diversification (Imagine the amount of time and money needed to achieve same diversification as a MF if you directly invest in stocks).
b) SIP (For any investor the ruppee cost averaging can'nt be better achieved thru MF SIP)...


Nilesh said...

Rohit, "Low cost mutual funds" -> can you please point me to any. whatever mfs i find charge 2.25% as entry load, no exit load and abt 2-2.5% in annual charges. so i dont think we can separate MFs on basis of costs (atleast in india).

h# said...

well, Nice post. I do agree that mutual funds are a nice way to park your money and SIP. But I would just park my money until I come across an investment idea. I will then liquidate my MF portfolio to push cash into my equity portfolio. Other way to use mutual funds specially debt funds is when you decide to sell a substantial portion of your portfolio and be in cash sensing an overheated market.

sri said...

Its always safe to go MF ways as We cannot predict the market in right ways and if u r new to market then there is more chance of losing money than gaining :)