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Understanding Mutual Fund With a different perspective

Understanding Mutual Fund With a different perspective

On friendship day, one of our friends asked us “you keep talking about investment to people, why don’t you tell me some good investment” . We said that you should look at regularly investing in Mutual Funds. But the moment we said Mutual Fund, He replied ” I have heard that Mutual Funds are not safe and it is better to invest in policies of LIC or other insurance companies. They offer better return as well.”

Plants

Now this is something which is very common to hear. Many investors have not yet understood that in fact mostly all the investment that you make today are mutual funds (collective investment schemes) only. Now whether you invest in LIC’s Future plus or HDFC Standard life’s Youngster Plan or ICICI’s unit linked plan or you buy New Pension scheme by government or any of the endowment plans, they all are nothing but mutual fund based investments.

To understand it in better manner,we need to understand how your savings are channelized in economic activity.

From the time we got independence in 1947 and till late 80’s the economic activity was mainly driven by government.It was government who build the road, set up power plants, started schools, build hospitals and what not . So they were in need of money to finance all these activities. It was government who needed to borrow the money and since government has the power to print the money, all the schemes through which they used to borrow, they all were GUARANTEED RETURN products.

But later on since early 90’s when our economic was opened up, the private sector took the lead and majority of our economic activity are now in the hand of private sector. Government has become more of a regulator. Now roads are built by private companies and we all pay toll charges. Not many would go to government hospitals or government school. Power is generated by Reliance Power, Tata Power etc. Now private sector needs finance to run the show.

But the point is that they cannot print money if they incur losses but government could do that. So your saving are now given to private sector and government is not much interested as they are able to meet their expense by way of tax collection.

In fact, just to emphasis that government is not interested in borrowing your money we would like to give couple of complete examples.

  • Earlier, there used to be a SMALL SAVINGS DEPARTMENT in all the districts of Rajasthan and agents were given heavy commission to collect the money. Many of you would remember those CHANDI KE SIKKE which investor used to get from agent if you invest in NSC ( National Savings Certificate). Sometime back, all the district level division were closed and now there are only two officers handling Small Savings Agency in Jaipur.
  • Earlier, most of the policies of LIC used to be GUARANTEED RETURN Policies as government used to borrow from LIC and since government gave guarantee, in turn LIC gave you guarantee. Now LIC has also stopped giving Guarantee in almost all the policy that they run.

Basically the government is now concentrating more on revenue based inflows like income tax, service tax etc rather than borrowing based inflows like PPF, Post Office etc.

Now, coming to our main discussion, when your saving goes to private hands, return cannot be GUARANTEED. Now we need a help of specialist who would guide a common investor to whom should he lend, where should he invest. Now here comes to role of mutual fund where you have a specialist who guides you where to invest your money and since there is no guarantee, the investment value is based on market valuation which is nothing but NAVs.

So whether you invest directly through mutual funds or through Insurance based products, you are buying market-linked investment only. But our friend thinks that Insurance policies offer better return. Why does he think so?

The reason behind is the Mis- Selling tactics used by agents and insurance companies. Since insurance is by law a long term product, it is easy for agent to mis-guide investors at the time of sales as they know that the investor will only come to know after so many years and till that time, they would have earned their heavy commissions. WHO CARES.

But when it comes to someone who distributes or sells you Mutual Fund directly, one That he hardly get any commission form the mutual fund company at the time of sales; secondly he knows that mutual funds can be withdrawn at anytime and are very transparent, they cannot mis-guide  people by showing that they will get high returns. A mutual fund distributor will only say that you will get returns based on market.

For our reader, please note that

1. Almost all the products are now market- linked and products which still offer GUARANTEE are most unsuitable for long term wealth creation as they cannot beat inflation and are most tax- unfriendly.

2. Mutual Fund investment is now everywhere, whether you take Mutual Funds directly or go through indirect way of mutual fund investment which is insurance companies. Its better that you understand Mutual Funds as soon as possible. In fact, post 2004, whosoever who is joining government sector is putting his compulsory retirement contribution to NEW PENSION SCHEME which is nothing but mutual Fund. What they will get at the time of retirement will be determined by market and government is not guaranteeing anything.

Direct investments to Mutual Funds are simple to understand and offer much needed transparency. After all these discussion, we still left the last decision with our friend; eventually, it is his money and it is his choice. we can only give our recommendation!

Published on TFL 2010
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  • Praveen July 2, 2015, 11:58 am

    Please clarify a small point, would the ULIP schemes be investing in mutual funds or is it just that their investments are akin to mutual funds. And in case they are investing in mutual funds why is it that this is not made public as to which ones are being invested in?
    TIA,
    Best rgds,
    Praveen.

    Reply