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Basics of mutual fund investing

Using a simple style, this ambitious book aims to help lay investors overcome their fear of learning the basics of mutual funds. Though targeted at a US audience the book is useful to Indian readers too.

Devangshu Datta | Print Edition: January 10, 2008

The New Commonsense Guide To Mutual FundsPrice: Rs 225

Pages: 272

By Mary Rowland

Published by Vision Books

The introduction to this book claims that “63 million Americans own mutual funds but most investors don’t understand what they have”.

That is the knowledge gap that author Mary Rowlands has tried to fill both in this slim guide as well as in her popular columns for the New York Times, Bloomberg and Microsoft Online.

Americans don’t hold the patent on financial ignorance. Relatively fewer Indian investors have mutual fund exposure and the ignorance about funds in India is just as all-pervasive. Many investors believe for instance, that a fund with a lower net asset value (NAV) is “cheaper” than one with a higher NAV. (It isn’t; the lower NAV means less assets held per unit).

So, despite the US slant, this book could be very useful to Indian readers. Actually the Indian mutual fund industry’s practices are modelled on and regulated by imitation of the best US practices.

DOS AND DON'TS

Do invest chiefly in the stock market and don’t buy bond funds
Do build your portfolio with at least three “core” mutual funds
Do start with one fund if that’s all you can afford
Don’t pay attention to what a fund calls itself
Do use index funds and don’t try to time the market
Do invest in different asset classes
Don’t buy asset allocation funds
Do manage your own cash and don’t trade with your emotions
Do look for consistency
Don’t buy if a fund has a high turnover
So, it isn’t all that different an environment though of course, the specific funds and managers and tax treatment are different. In order to invest effectively via mutual funds, an individual needs to understand a certain amount of generic information about funds as instruments.

He also needs to make actionable decisions or receive good advice about specific funds to buy and sell. Rowland says she has learnt from years of interaction with readers that unfortunately, most people have a psychological block about learning generic stuff.

Most shy away from making the (not very onerous) intellectual effort required to understand the basic characteristics of funds. Most at the same time, are desperate to get actionable advice–the “tips”. This is what leads to the creation of haphazard portfolios.

Rowland set herself an ambitious task in this book. She would work around this resistance and somehow retain her readers long enough to get those generic concepts into their heads while evangelising for the cause of investing in equity mutual funds.

Her solution was to follow a “back-to-front” format in structuring this book. The first part (“Part I: Dos and Don’ts”) consists of a large set of simple rules—75 (!) concepts to keep in mind when investing in funds.

Each of these rules and the rationale(s) behind it is explained in a page or two. This is for the people who want actionable advice–it even includes a few suggested portfolios (of US funds of course).

I think she was trying to create a long but mechanical algorithm, which could be applied by an investor: every time you decide on some financial action, run through the list and see if these rules are violated. Now 75 rules may seem like a lot but actually it is both too few and too many.

There are too many rules to be applied easily though most are sensible enough in themselves. At the same time, no fixed set of rules will ever be large enough to substitute for sound overall understanding of the subject.

At some stage, successful investors do need to work their way past the block against serious mental effort. “Part II: Building Blocks” is all about the nuts and bolts of mutual funds and a good place to start acquiring systematic generic knowledge about funds.

This is where a beginner should really start. This section has a brief history of funds and explains basics such as NAV, loads and tax structures.

It also has quizzes and checklists devoted to the factors you must consider before buying and selling. “Part III: Risk and Asset Allocation” is crucial of course, to all investors and its importance is often underplayed in financial literature.

A couple of influential studies suggest that over 90% of financial returns might depend on the choice of the class of instruments and the portfolio mix (where classes include equity, cash, commodity, gold, real estate, etc) rather than the specific funds or shares held.

Asset allocation theory does suggest that a skillfully applied blunt instrument (split your assets in the right proportion rather than agonising about the exact composition) is often enough to do the job.

Rowland offers a decent introduction to the subject. “Part IV: Common Sense Strategies” is perhaps the most interesting for a somewhat-evolved investor. Here the author describes and discusses some of the better-known strategies followed by investors.

The debates about the active versus passive styles of investment and the concept of buy and hold, rotation, using theme funds, bond funds, etc come into the picture.

"A strategy can be simple. Not every successful investor uses the same strategy. But every successful investor has one. Successful investing is never haphazard. It requires a plan." - “Commonsense Strategies” Page 233

As she points out, discipline is the one key factor–you can follow disparate strategies and be successful so long as you have discipline and consistency. The entire book is written in a very simple, almost simplistic, language.

Certain elements of the format (many changes in fonts and emphasis, many checklists, repetitions of the same points,) are selfhelp in style. However it makes no extravagant promises about transforming your life in the way that bad self-help texts are wont to do.

The author’s recommendations about specific investment styles may not suit every reader. But they are mainstream and unlikely to trigger disaster. Overall, it’s a good introduction to the basics of mutual fund investing.

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