Why or Why not Mutual Funds?

What  is Mutual Fund?

A mutual fund is an investment vehicle where many investors pool their money to earn returns on their capital over a period. This corpus of funds is managed by an investment professional known as a fund manager or portfolio manager. It is his/her job to invest the corpus in different securities such as bonds, stocks, gold and other assets and seek to provide potential returns. The gains (or losses) on the investment are shared collectively by the investors in proportion to their contribution to the fund.

Why should you invest in Mutual Funds?

The primary benefit of investing in a mutual fund is that you get exposure to a variety of shares or fixed income instruments. For instance, if you wanted to invest Rs. 1,000 directly in stocks, you would probably get only a share or two. If, on the other hand, you invested through a mutual fund, you would get a basket of several stocks for the same amount.

These are the main types of mutual funds:

 

·         Stock (equity) funds typically carry the greatest risk alongside the greatest potential returns. Fluctuations in the stock market can drastically affect the returns of equity funds. There are several types of equity funds, such as growth funds, income funds and sector funds. Each of these groups tries to maintain a portfolio of stocks with certain characteristics.

 

·         Bond (fixed-income) funds are typically less risky than stock funds. There are many different types of bonds, so you should research each mutual fund individually in order to determine the amount of risk associated with it.

 

·         Balanced funds invest in a mix of stocks, bonds and other securities. Balanced funds (also called asset allocation funds or hybrid funds) are often a “fund of funds,” investing in a group of other mutual funds. One popular example is a target-date fund, which automatically chooses and reallocates assets toward safer investments as you approach retirement age.

 How mutual funds make you money

 When you buy into a mutual fund, your investment can increase in value in three ways:

1.     Dividend payments: When a fund receives dividends or interest from the securities in its portfolio, it distributes a proportional amount of that income to its investors. When purchasing shares in a mutual fund, you can choose to receive your distributions directly, or have them reinvested in the fund.

2.      Capital gains: When a fund sells a security that has gone up in price, this is a capital gain. (And when a fund sells a security that has gone down in price, this is a capital loss.) Most funds distribute any net capital gains to investors annually.

3.      Net asset value: Mutual fund share purchases are final after the close of market, when the total financial worth of the underlying assets is valued. The price per mutual fund share is known as its net asset value, or NAV. As the value of the fund increases, so does the price to purchase shares in the fund (or the NAV per share). This is similar to when the price of a stock increases — you don’t receive immediate distributions, but the value of your investment is greater, and you would make money should you decide to sell.

How to invest in mutual funds?

 Decide whether to go active or passive

Your first choice is perhaps the biggest: Do you want to beat the market or try to mimic it? It's also a fairly easy choice: One approach costs more than the other, often without delivering better results.

Actively managed funds are managed by professionals who research what's out there and buy with an eye toward beating the market. While some fund managers might achieve this in the short term, it has proved difficult to outperform the market over the long term and on a regular basis.

Passive investing is a more hands-off approach and is rising in popularity, thanks in large part to the ease of the process and the results it can deliver. Passive investing often entails fewer fees than active investing.

Calculate your budget

Thinking about your budget in two ways can help determine how to proceed:

How much do mutual funds cost? One appealing thing about mutual funds is that once you meet the minimum investment amount, you can often choose how much money you’d like to invest

Which mutual funds should you invest in? Maybe you’ve decided to invest in mutual funds. But what initial mix of funds is right for you?

Generally speaking, the closer you are to retirement age, the more holdings in conservative investments you may want to have — younger investors typically have more time to ride out riskier assets and the inevitable downturns that happen in the market. One kind of mutual fund takes the guesswork out of the “what's my mix” question: target-date funds, which automatically reallocate your asset mix as you age.

Mutual fund pros and cons

Still trying to decide if mutual funds are for you? Here are the pros and cons.

 Pros

These are the primary benefits to investing in mutual funds:

·         Simplicity. Once you find a mutual fund with a good record, you have a relatively small role to play: Let the fund managers (or the benchmark index, in the case of index funds) do all the heavy lifting.

·         Professional management. Active fund managers make daily decisions on buying and selling the securities held in the fund — decisions that are based on the fund's goals.

·         Affordability. Mutual funds often have a required minimum amount as low as RS 100, but several brokers offer funds with lower minimums, or no minimum at all.

·         Liquidity. Compared with other assets you own (such as your car or home), mutual funds are easier to buy and sell.

·         Diversification. This is one of the most important principles of investing. If a single company fails, and all your money was invested in that one company, then you have lost your money. However, if a single company within a mutual fund fails, your loss is constrained. Mutual funds provide access to a diversified investment without the difficulties of having to purchase and monitor dozens of assets yourself.

Cons

 Here are the major cons of mutual funds:

·         Fees. The main disadvantage to mutual funds is that you’ll incur fees no matter how the fund performs. However, these fees are much lower on passively managed funds than actively managed funds.

·         Lack of control. You may not know the exact makeup of the fund’s portfolio and have no say over its purchases. However, this can be a relief to some investors who simply don’t have the time to track and manage a large portfolio.

Investing and Smallcase

Many of us in this lockdown have at least thought or studied or invested in stock market. For the beginners it is really tough to analyse and study. Mostly, we tried to join a random group or to get suggestions on which stock to invest and how much to invest in those stocks. Some of us blindly followed these random suggestions and trusted others.

In this randomness I tend to found out an App named Smallcases.

To simplify Smallcases are a new way to invest in stocks. A smallcase is basically an intelligently weighted basket of upto 50 stocks that reflects a theme, idea or strategy.

If you are investing in smallcases, you get the direct ownership of the individual stocks bundled together in a portfolio. This is different from mutual funds, where you don’t have ownership rights in the stocks that form your mutual fund portfolio but you hold units of the portfolio.

Smallcases are centred around a trending market theme probably rising rural demand or a financial model like zero debt or different risk profiles viz. aggressive, balanced and conservative (they also explain which type of variants will likely suit you or which type of investment will be better).

Smallcases, the stock selection for a theme is a result of well documented research processes and it's ensured that the selected stocks aptly represent the particular theme. If an investor spots a particular trend and believes that the trend will last long enough to make a significant difference in terms of capital gains, then he/she can invest in such themes by using Small case’s tailor-made portfolios. Investors can customize their Smallcase portfolios if they wish to. Stocks can be added and removed.

Smallcases aren't a means of recommending or advising investors. Choosing a smallcase is upto each individual. Mostly, provide you exposure to trending market themes (GST, smart cities) & investing styles & strategies (Buffett, Graham, Greenblatt).

A brokerage account is mandatory to trade in smallcases.  Since you will be investing in stocks directly, a trading account and a Demat account is required. Smallcase Technologies has partnered with brokerages such as Zerodha, HDFC securities, Kotak Securities, Axisdirect, Edelweiss, 5paisa and Alice Blue.

When you invest in smallcase, money is debited from your trading account and stocks are credited to your Demat account.

Smallcase does not charge any fee individually for its portfolio. The fee is charged by Smallcase’s brokerage partner.

All its partners, namely Zerodha, HDFC Securities, Axis Direct, Edelweiss, and 5paisa, charge Rs.100 as the fee for the first transaction on a particular Smallcase portfolio.

Once the investor has paid the Rs.100 fee after selecting a certain Smallcase portfolio, then no subsequent fee is charged for further investments made in that particular portfolio.

For example, let us assume that an investor starts with an Rs.10,000 investment in the “Smart Cities” Smallcase.

During this first Rs.10,000 transaction, a fee of Rs.100 will be charged. This Rs.100 is irrespective of the investment amount.The initial investment amount can be Rs.10,000 or Rs.50,000. The fee will remain Rs.100 for that first transaction.

Subsequently, if the investor invests another Rs.1 lakh, then there will be no Smallcase fee. Only brokerage and other charges, as charged by the broker, will be applicable.If that same investor also invests in another Smallcase portfolio, like “Smart Beta”, then another Rs.100 will be charged for the very first investment made in “Smart Beta”.Then, subsequent investments in “Smart Beta” or “Smart Cities” will not attract any Smallcase fee. All investment transactions, however, will attract brokerage-related charges.

If you are having a thought how it is different from Mutual Funds? 

So let me tell you this when you buy from smallcase you become a direct shareholder of those companies present in the Stock Basket when you invest ‘through’ Smallcase. But when you invest ‘in’ a Mutual Fund, you are just buying the Units of Mutual Fund and not the stocks that make up the portfolio of the fund, so you do not become a proud shareholder of a company when you invest in a Mutual Fund.

When a Mutual Fund buys or sell any stock from their portfolio the tax burden is not carried by the Mutual Fund Unitholders but when a Stock Basket is re-balanced, the tax burden that comes with the re-balancing falls on the portfolio owner.

Different Categories in Smallcase are:

For New Investors – It is for the newcomers, who are just starting into Direct Equity Investment. There are 6 Baskets present at the moment in this category. Most of the Stock Baskets in this category contains Big, Established, Bluechip Companies.

Smart Beta – The baskets on this category are mainly for passive investors. The Stock Baskets in the Smart Beta category mostly consists of well established Large Cap companies. This category aims to provide a market-beating return at low risk.

ETF Smallcase – Stock Baskets in this category are made out of ETFs or Exchange Traded Funds(Will make a blog on this too). The baskets are more geared towards general market investing. As the cost of each ETF Unit is low so does the baskets in this category.

Long Term – This category mostly contains baskets oriented around the public consumption sectors of the economy like Private Banking, Logistics and Transportation, Purchasing Power of the Indian Middle Class, etc.Stock Baskets from this category are designed for Long term investment. An intermediate investor who will not panic during a crisis like the Pandemic should invest through the baskets present in this category.

Dividend Income – By far the favourite category of ours.The Stock Baskets in this category are made to provide Investors with a regular income in the form of Dividends. These baskets again mostly contain Big, Established, Dividend Paying Bluechip Companies and some of them have paid dividends to their shareholders for more than 10 Years.

Sector Trackers – The baskets in this category are simply different economic sector tracker. In this category, Smallcase has a basket starting from Auto to FMCG to Infra to Pharma to Realty.As Sectorial Investing comes with its own set of risk, these baskets are not ideal for any Begineer Investor.

Government Reforms – By the name you can understand that this category contains Stock Baskets that are focused on the Government Policies and Reforms. All the positive initiative from the government will reflect in these baskets.

Growth Investing – Baskets in this category are made following any particular famous ‘Methodology’ of Investing. As the stocks in these baskets are chosen because of their Growth Potential, the risks associated with these baskets are high too.And along with all these categories when you login in with a particular broker, you will find some more Category or Stock Baskets which are associated or might be developed by that broker.

To conclude:

Stock Baskets are still new in India also the reality of investing through Stock Baskets is different. Regular portfolio updates and re-balancing will take a chunk out of the investor’s profit in the form of Taxes. And not to mention the loss borne by investors due to selling of securities when they are in the red. For me, Smallcase is a great tool to find new companies in different sectors and themes but it is not the right investment medium for Direct Equity Investment. We would use Smallcase as a Screener rather than an Investment Medium.

Disclaimer: This is my opinion and not paid promotion ;)