What is the best Mutual Fund to invest?

There is no single best fund to invest. There are different types of funds that can be chosen for different types of requirements.

The fund that is most appropriate for most Indians is the Equity Large and Mid Cap fund, which invests in shares of Indian companies listed on the National Stock Exchange or the Bombay Stock Exchange. The reason why this type of fund is most appropriate is because most Indians do not invest in equities in a systematic long term manner to build wealth. The absence of this fund in your portfolio will cause large and lasting damage to your financial well being. These funds are best used for investments of 10, 20 even 30 years. An investor can choose to supplement these funds with Small and Mid Cap funds to boost risk and return. For a young person investing for a long time, this is the fund that matters.

For those who wish to place large sums of money for a short period of time, it is better to go with short term debt funds. These funds are easily replaced by bank fixed deposits, but they are usually better than bank FDs. In any case, even if you do not have these funds in your portfolio, it will not cause much harm unless you are placing very very large sums of money idle in a bank account. This is a 'nice to have' fund for most Indians, and a 'must have' fund for cash rich Indians.

Other funds are useful if you have a specific view on the share market. For example, infrastructure funds, pharma funds, technology funds, etc. are useful only if you believe that these sectors will do better than the economy as a whole. Similarly, long term debt funds are useful if you believe interest rates will fall.

From here on complexity in Mutual Funds increases. There are many funds for many different requirements. There is, however, NO single best fund.

What returns can I expect from Equity Mutual Funds?

Equity Mutual Fund returns are highly volatile. However, over the long term, typically five years or more, they are also highly rewarding. Returns on Equity Mutual Funds depend on the investments they make. Large Cap Funds tend to have stable returns. Mid Cap Funds offer higher but more volatile returns.

In this post I am considering just these two fund types and comparing them to Bank FDs

Here are the ACTUAL annual returns on various categories of Equity Mutual Funds from four top fund houses: DSP, HDFC, ICICI and UTI over the last 3, 5 and 10 years as on Jun 21, 2016:

Equity Large Cap funds: 15.41% in 3 years, 10.17% in 5 years and 11.76% in 10 years.

Equity Mid Cap funds: 31.65% in 3 years, 17.44% in 5 years and 13.44% in 10 years.

Comparable returns on Liquid funds have been

Debt Liquid Funds: 8.67% in 3 years, 8.85% in 5 years and 7.80% in 10 years.

Now, Bank FDs provide about 1% less than Liquid Funds at about 6 months tenure. This difference adds up. At 6.8% return (10 year liquid fund return minus 1%) a Bank FD would grow Rs. 1 lakh to Rs. 3.7 lakhs in 20 years. If we include the impact of 30% tax as applicable on Bank FDs for top income tax bracket, the growth in Bank FD would be Rs. 1 lakh growing to Rs 2.5 lakhs in 20 years.

The average large cap fund would grow Rs. 1 lakh to Rs. 9.2 lakhs in 20 years. The average mid cap fund would grow it to Rs. 12.5 lakhs. There is more. The BEST large cap fund would grow Rs. 1 Lakh to about 21.5 lakhs over 20 years (if we assume that the 10 year return would be valid for a 20 year period also). The best mid cap fund would grow Rs. 1 Lakh to Rs. 56 lakhs. And all Equity fund returns are tax free after a year of holding. So no tax is payable at all.

The net net is this: it is extremely loss making to invest money for the long term in Bank FDs. ACTUAL history shows that in the last 20 years investors lost Rs. 55 lakhs in trying to protect Rs. 1 lakh.

Invest based on what you need, not what you like

Often a person’s investment is driven by his risk appetite. Conservative persons cannot stand to lose money and so prefer safe investments like bank deposits. Risk loving persons, on the other hand, avoid safe investments because they like the feeling of risking money to make stupendous returns.

Actually, it is probably a bad idea to choose an investment based on how much risk you like. It is far more intelligent to consider what you want to achieve through the investment. I am sure you would agree that it is intelligent to use a hammer to drive a nail and to use scissors to cut paper. In the world of investments, however, there are many persons who would use a hammer to cut paper because they ‘like’ a hammer.

The safest, simplest instrument is a Bank Fixed Deposit. You put money for a fixed duration of time and get a fixed amount of money at the end of that period. It is useful for short term requirements such as putting aside money for kids’ school fees or even buying that expensive iPhone for Diwali. These deposits provide anywhere from 5% to 9% return depending on interest rates and duration of investment.

The Short Term Debt Mutual Fund offers 5% to 9% returns and is a little riskier than the Bank Fixed Deposit. It is the preferred choice of sophisticated investors such as companies and rich individuals because it is ‘liquid’, which means you can invest and withdraw money from a Short Term Debt Mutual Fund easily at any time, and because these Funds attract lower tax rates if held for three years or more.

So the Fixed Deposit and Short Term Debt Mutual Fund is useful to keep money parked for a year. They are products investors 'like.' Both the Bank Fixed Deposit and the Short Term Debt Mutual Fund are harmful, however, if you want to save for retirement, or for your Children’s college education, or their marriage.

When dealing with investments that have to last for twenty or thirty or forty years, you need to look at Equity Mutual Funds. These are risky but offer great long term returns and they are essential if you want to build wealth for the long term. The Bank Fixed Deposit or Short Term Debt fund are worse than useless for these durations.

A person investing his January Bonus in Equity Mutual Funds so as to buy a Car at Diwali in October is like a person using a hammer to cut paper. Similarly, a person saving in a Bank Fixed Deposit for his retirement is like a person using scissors to drive a nail. Yet, investors often invest only in Bank Fixed Deposits for ALL purposes because they believe that these instruments are safe. Some others put all their savings into share trading in the vain hope that it would mushroom into a massive sum that would make them rich overnight.

A good investor studies all instruments and astutely uses the one that best suits his purpose. The correct application of an investment to a purpose is financial wisdom.