By Rishabh Parakh
“ Kya Mutual Funds Sahi Hai”
That was a question from Sneha, daughter of an old client.
I smiled and told Sneha, “Everything is right, sab kuch sahi hai.”
I told her that many individuals have earned a lot of money in stocks in recent months. Stock prices fell sharply due to the coronavirus virus, and those who invested at the right time have made the kind of returns you are talking about.
“If you are confident that you can continue getting similar returns for the rest of your life and can devote time and money to investing in stock markets, you should invest in stocks,” I told her.
I told her not to look at this in isolation.
“When the market crashed earlier this year, mutual fund prices NAVs crashed. So did stock prices. In fact, stocks tend to have bigger ups and downs than mutual funds because mutual funds are diversified by their very nature,” I told Sneha.
“The way the market works and the underlying factors have changed. Life was simple when Apple and BlackBerry were just fruits. The way we used to look at mutual funds or stock market investing 20 years ago is very different from the way we look at them now. Customer behaviour has changed. Customers have evolved and have gone from “we think” to “we know”. We say that data is the new oil, but it’s equally important to understand that this data needs to be refined before we can make use of it,” I tried to explain the situation to Sneha.
Sneha was still stuck on huge returns given by stocks recently. “But aren’t stocks giving great returns right now? Isn’t it better for me to buy stocks and make great money,” she asked.
“Yes, it is true some stocks have given great returns. But as I said earlier, will they repeat the performance,” I asked her.
I told her that investing in select stocks and remaining invested for the long term is good, provided you can monitor it and know what to buy, when to buy, and when to sell. Can you do it consistently while keeping an undiluted focus on your job or business?
“You are your own stock and the biggest returns will come from focusing on your career. Stock market or mutual fund investments should be a part of your overall asset allocation. You should invest in asset classes across and there cannot be a favourite fund or an asset class like you do not have a favourite medicine. You invest it to diversify your risk and to earn decent returns. Unless you want to get in to the stock market as your main business like a fulltime investor, then it is perfectly fine. Otherwise, you would be fine with diversifying your investments across some good mutual fund schemes, which can include index funds or multi-cap funds based on your risk profile,” I explained to her.
Sneha thought about it for a bit. “That makes sense. How can I go about it then? How can I choose the right product for me,” she asked.
I smiled and told her that she is asking the right question now.
“You need to sit down and form a goal-based financial plan. Understanding the kind of returns that you need to achieve your goals will give you clarity on the kind of risk you can take. It is always said that higher the risk, higher are the returns. I beg to differ on this. Higher the risk higher should be the returns. Stocks can give great returns, and you can do it, provided you have the time, money, and expertise to handle stock market investing along with your fulltime job or business. If not, mutual funds are the way to go,” I told her.
I also explained to her that she would not get the kind of returns individual stocks are offering from mutual funds. But they also wont fall as sharp as individual stocks. The potential for loss in the stock market is exponentially greater. That is why it is extremely important to invest on the basis of your risk profile and financial planning.
Sneha looked convinced. She particularly liked the concept of investing for one’s financial goals based on the risk profile. I sincerely hope she would make the right decision.
(Rishabh Parakh is a Chartered Accountant and a founder of Money Plant Consultancy. He is also author of Financial Spirituality.)