Myth 1: Funds with highest *Star Ratings* or Rankings make better buys
Beware! While you may be tempted to invest your hard earned money in that 5-Star rated Fund, let us throw some light on what could be the consequences of doing the same.
It is commonplace for Fund Houses to flaunt the number of *stars* / points their funds have garnered. In turn, the same is utilized by distributors and agents alike, to convince investors about the merits of the fund. There is nothing wrong with the idea of granting rankings / star ratings to Mutual Funds. However, you should not completely depend on them.
Our Concerns regarding rankings and ratings stems from the following two reasons:
Firstly, the method of computing rankings/ratings tends to be largely quantitative. The norm is that risk-adjusted returns (i.e. returns clocked by a fund vis-à-vis a risk-free investment avenue) and performance vis-à-vis similar funds are the factors considered.
Qualitative factors like the fund management team’s skill sets and the processes followed by the fund house are never factored in. Similarly, fund-specific features like the portfolio management style or adherence to the stated investment style are not considered in the rankings/ratings process either.
Secondly, it is important to understand the nature of the fund and whether it is fit for a particular investment objective. A 5-Star rated fund need not be suitable for your Portfolio. Why? If you are going to invest for a period of 3-6 months, a 5-Star rated Equity Fund or Balanced Fund is not a right selection. Similarly, for a 10 year time horizon, a 5-Star rated liquid fund is the wrong choice.
The Reality: Star Ratings cannot help you make the final decision on funds. They are, at best, a starting point.
Myth 2: I don’t want to invest in Mutual Funds… I prefer investing only in stocks
Who wants to invest in financial instrument like a mutual fund that probably grows half as fast as some ‘exciting’ stocks during a bull run? The poser is relevant. Underperformance almost always gets a thumbs down, no matter what the reason. After all, every investor wants his money to work for him and if a stock does that better, why invest in a mutual fund?
Mutual funds may lack the excitement of a stock, but it’s the kind of excitement that investors can often do without. Mutual funds may not scorch the investor’s portfolio in a bull run like some ‘exciting’ stocks, but you can be sure they won’t burn a huge crater in the investor’s portfolio either, when individual stocks are crashing by 40%, for instance.
You as an investor have the liberty of investing in stocks, debt funds and Gold.
The Reality: Mutual Funds give you the privilege of diversifying your Portfolio by allowing you to access other’s expertise.
Let me tell you a good story. A father and his son were once traveling to their native place. The son who was carrying a lot of money with him put all the money in his shirt’s pocket.
Seeing this, his father said, “Son, don’t put all the money in your shirt, keep aside half the money in your socks”. By doing this, you will not lose all your money if you get robbed!
The Moral: Don’t put all your eggs in one basket!
So, would you prefer investing your hard earned money in Mutual Fund Schemes based on *star ratings* or choose ‘fundamentally researched’ Mutual Fund Recommendations?