Equity mutual funds received a staggering Rs20,000 crore in the month of August. While foreign institutional investors (FIIs) have been pulling out from the Indian stock market, domestic institutional investors (DIIs) have provided strong support to markets. What is driving this growth in mutual funds? Are investors really understanding the risk attached with equities or the growth is driven by herd-mentality.
One reason for the rise in equities is low return given by other asset classes. While fixed deposit have been giving abysmal low return of 6-7%, property market has also been in slump for many years. In such a situation mutual funds have caught the fancy of many people who have been looking for other avenues to earn higher returns. Over the last one year equity diversified and small cap funds have given returns as high as 30 and 40 percent, respectively in last one year.
What make mutual funds hugely popular recently is the growth in systematic investment plans (SIPs). Today, there is an inflow of Rs4000 crore every month through SIP. What worries, however, is when you see people investing in mutual funds without understanding the risk of the product. I have heard and seen several people selling balanced mutual funds as an alternative to fixed deposits. Go to any nearby bank and chances are high they will pitch you balanced fund as an alternative to fixed deposit. The person at the desk might not care to tell you that unlike fixed deposit a balanced fund is a mix of debt and equity. Their return is not guaranteed and are subject to stock and debt market risks. I am not opposing the idea of investing in mutual funds but the point is you should understand the risk before investing in any product. One cannot deny that balanced funds have given very high return over the last few years and they are tax-efficient also. But one should also understand the risk attached with these schemes. Unlike fixed deposits the return over here is not guaranteed.
Another area of concern is when you don't link your investments with your goals. When you do not link the two you do not know for how long you want to stay invested. When you don't know the time horizon chances are high that you will not invest in the right product. There are many people around who have invested in mutual funds without a clue about their goals. Identify it whether it is for your education, marriage or retirement. Do not invest in equities just because your family members and colleagues are doing it. Doing so you contradict the golden rule of investing which says that you should invest in equities for at least 3 to 5 years.
With expense ratio of just 2- 3% mutual funds are certainly one of the cost-effective ways of investing in equities. They can give you inflation beating return when all other asset classes are not performing well. But before investing do understand their risk and most importantly stay invested for long term.