We all acknowledge that mutual fund investment is one of the foremost revolutionary ideas within the world of finance. In just the previous year itself, the assets under management with the mutual funds in India have gone up by 41% to about 31.43 lakh crore rupees.
It clearly states that Indians are getting super enthusiastic about making strategic investments. But there are very few who know that merely due to unawareness about a basic principle despite investing properly, there is one way by which you and have been losing out on a large chunk of your investment returns.
In this post we’re going to learn not just about the fundamentals of mutual funds but along with that we’ll also learn about an open secret that is going to save you a minimum of 2-3 lakh rupees.
Now, just to establish context, let’s quickly try to understand the working of mutual funds? A mutual fund is a name given to a pool of money that is strategically invested by an asset management company just so that it can give out the best returns possible to small-scale investors.
Before 1963, there were certain very big problems prevailing in the market.
- Number one, there were a lot of people like you and me who had little sums of money that they wanted to invest but they did not have any knowledge about investing.
- Secondly, there were amazing companies with amazing business propositions. They had the best product and services that could generate million-dollar profits. However, they did not have enough capital to keep their cash flow going, eventually accelerating their growth.
- And thirdly, some people had perfect knowledge about which companies to invest in to earn maximum possible returns on the capital. But they did not have the capital themselves to invest in all of those companies.
This is where mutual funds came in, where the money is accumulated from all the small investors by the financial and business experts, then these business experts use their knowledge to carefully invest that money into amazing companies. Eventually, the amazing companies get capital, they generate cash flow, and eventually, they scale their growth to deliver great profits.
So, this creates a win-win-win situation wherein the company makes money, the experts get paid for their knowledge and the investors like you and me, get paid for our capital. This is the basic idea of mutual funds. Now, just to put this in perspective the investors are people like us. The business and financial experts are what we call Asset management companies (AMC). And the money that they make is what we call commission.
And the kind of investment they make is what gives rise to the different types of mutual funds. Now, depending on where your money is invested, we’ve got 5 broad categories of mutual funds.
1. The first category is equity funds.
2. The second is debt funds.
3. Next we’ve got hybrid funds.
4. Then we’ve got solution-oriented funds.
5. And at last we’ve got other schemes.
If you have a high-risk appetite then a standard recommendation is that you must invest in the first type, that is, equity funds. In equity funds, typically you’ll see that 65% of the assets get invested into equity and equity-related instruments. But if you want to play safe and take less risk. That’s where the second type of mutual fund comes into play and this is what we call a debt mutual fund also known as a fixed income fund. This is where a significant portion of your money gets invested into fixed income securities like corporate bonds, debentures, government securities, etc. And then we’ve got the third type and this is what we call hybrid mutual funds and as the name implies, here’s where your money gets divided into different proportions both into equity and fixed income securities. Apart from that, you’ve got solution-oriented funds which are usually meant for retirement funds or children funds. And then you’ve got other schemes like index funds etc.
Now I come to the catch of the matter. Until this point, most people are aware of these things. Most people know about types of mutual funds and how it works. But you know what? There is one basic thing that most people, either don’t know about or simply underestimate and that is the significant difference between direct mutual funds investment and regular mutual funds investment. To tell you about it, there are two methods by which you can invest in mutual funds. The first method is the regular method and here’s where you go to a mutual fund distributor or advisor then this distributor facilitates your money into an AMC and then the AMC invests the money into financial instruments. Over here, you have to pay commissions to two entities: the AMC and the distributor.
The second method is the direct method. This was introduced by SEBI (Securities and Exchange Board of India) in 2012. In this method, instead of going to a distributor you directly facilitate your money to an AMC which further gets invested into the financial instruments. Over here you have to pay commission only to the AMC and you can save up distributors commission. And like I said before the X factor that most people either neglect or underestimate is the huge difference this little distributor commission can make to your investment.
And here’s a simple calculation to prove this to you. Let’s say you invest 10 lakh rupees into Axis Bluechip Fund with a regular plan. Assuming that it gives you a return of 16.87%. After 10 years you will have 47,53,685 rupees. But if you invest the same 10 lakh rupees in Axis Bluechip direct plan you will get a return of 18.14%. So, after 10 years, you will have 52,96,264 rupees which is a difference of 5,42,576 rupees! Now, this is still less. If you look at a fund like Mirae Large Cap, things are even more amusing. If you invest 20,00,000 into Mirae Large Cap regular plan with the estimated return being 16.25%. After 10 years, you will have 90,14,872 rupees but if you invest the same 18 lakhs on a direct plan you will get a return of 17.36% and after 10 years you will have 99,13,591 rupees. which is a difference of 8,98,719 rupees. So, if you see merely by opting for the direct plan, you end up saving 5.45 lakhs and 8.98 lakhs respectively without paying a single rupee extra, in the same given time.