mutual-fund

Investing Tips: Will you invest in mutual fund or index fund?

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What is Mutual fund?

Mutual Fund is a financial vehicle through which money is invested in various instruments like equity (Shares), bonds, CDs etc. There is various types of mutual funds depending upon the objective of investors. For instance if investors wants a stable income and he is more risk averse, then investment in debt is preferred, which is called debt mutual fund.  Contrarily, if investor is having the capacity to take the risk and wants greater return, investment in shares (equity mutual fund) is preferred. Depending upon the risk profile of investor it can be the hybrid of two.

Investing in Mutual Funds vs Index Fund

There are other criteria for mutual fund classification like large cap mutual fund (investment in big companies in term of market capital), midcap or small cap and many more. But one important classification of mutual fund which we are going to analyze in this article is based upon the how actively your fund is managed. There are two types:

  1. Actively Managed Fund
  2. Index Fund

If you invest in actively managed fund then the fund manager will try to invest to get the maximum return. While investment in Index fund means the fund manager will try to mimic your portfolio to some index. For instance if it is the nifty 50  index fund then your portfolio investment return will be more or less same as of Nifty 50. Obliviously, fund manager of active managed fund will ask more fees to manage your fund as he has to do more research for the same. This is major source of revenue for them. For comparison in case of Mutual fund the commission (they call it expense ratio) can vary from 2-5% while for index fund it vary from 0.1% to 1%.

After this brief background, I will try to analyze the performance of both types of Mutual fund.

We havefocussed only on Largecap mutual fund. Here you can see that top largecap mutual funds in term of return.

mutual-fund

mutual-fund

The list is not exhaustive. But I have taken top performing mutual fund in term of return provided in last 10 years. You can see that Mirae Asset Large Cap Fund – Regular – Growthhas provided the maximum return of 14.39% in last 10 years. Ranking may be different for other time periods, but our focus is long term which I am assuming 10 years. Now let’s look at nifty50 return during same period.

Nifty 50

Date Index Total Returns Index
22-Jan-10 5030 6252
22-Jan-20 12106 16990.68
Growth (CAGR) 9.18% 10.51%

 

Index column is value of Nify50. It says that if you invest in nifty 50 you will get 9.18% per year return. But this wrong way to calculation the return. Here the dividend income is ignored (And it is not surprising that most of the analyst ignore this, especially when they compare it with return from Active Mutual Fund).  Hence dividends are over and above of these 9.18% return. To bring into account of Dividend income we have Total Return Index. It assumed that whatever dividend is received it is invested back in market, hence incorporatedividend effects. This 10.51% return will be earned if you reinvest the dividend received back into the Nifty 50. In finance terminology these are called growth fund. Most of the mutual funds are growth fund, so Total Return Index should be compare with active mutual fund.

One would argue that active mutual funds are earning more that the Nifty. So, one should invest in Active Mutual find.  Yes!It is right that some fund performed better than Nifty 50, but most of them not. Only 15 out of 43 funds were able to beat the Nifty 50. Infact, by investing in Nifty 50 one can easily beat 28 fund managers. And one very positive pointis that investment in Nifty 50 does not require any knowledge. A person, who have not heard of shares/stocks or does not possess any complicated financial analysis skills can earn this much of profit. In some other article I will explain one can easily increase make this return to 15% by doing very miniscule analysis.

Another interesting thing, many of funds have closed over the last ten years. These 43 funds, among which ranking has been done, are funds which hassurvived.It can be said that Nify50 has much more than 28 funds which were there 10 years back.

Now natural questions arises how come so much qualified fund manger not able to beat the Nifty50. We should not consider that these fund managers are dumb or don’t know how to do investing. In fact they are much qualified. There is logic behind why these fund managers are not able to beat the nifty50. There is problem with their business structure, which goes back to basic of economics. We will try to understand this in different article. I will end this article with interview of Warren Buffet where he said that he would not invest with active fund manager in India.

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