Wednesday, January 3, 2018

Is Lump Sum Investment in Mutual Funds a Good Option?

The option of investing in mutual funds has been gaining popularity among investors in India recently. The biggest issue with mutual funds for Indian investors has been that they invest in the equity and debt markets which are evidently subject to risks.

However market risks haven’t deterred investors to invest in mutual funds and the investments in this investment tool has been rising steadily. Lump sum investments are usually made in equity mutual funds thus for the purpose of this article mutual funds means equity mutual funds unless otherwise mentioned. Any investor knows that all kinds of investment tools are subject to the inherent terms and conditions of its governing factors. Lump sum investment in mutual funds is also a good option depending on a few factors; please find them discussed below: 

1. Use the P/E ratio as benchmark: New investors usually wait for the right time to buy (invest) and the right time to sell (redeem) mutual fund units but one should understand that it is next to impossible to determine the best time to do so. However to judge the market you can use the Price/Earning (P/E) ratio of a mutual fund as a benchmark. P/E ratio is valid for equity mutual funds and a fund’s P/E is calculated on the basis of its portfolio. Remember, when calculating a fund’s P/E for investment, one should consider its earnings from the last four quarters. If the fund’s P/E ratio is low then the chance of earning a profit from it is more, i.e. an equity mutual fund of SBI mutual funds with a P/E of 15 may fetch you better earnings than an equity mutual fund of the same fund house with a P/E of 22. 

2. Be in it for the long-run: If you are investing a large amount in equity mutual funds, then maintain your investments for a long tenure. The disadvantage of being short-sighted with lump sum investment in mutual funds is that if the market corrects itself significantly you will suffer a terrible loss in that moment. However with time the market and your mutual fund portfolio will stabilize by bottoming out (i.e. by stopping to fall any further). This is why it is recommended by experts to invest lump sum in an equity mutual fund only after evaluating the fund’s performance over a long period of time and if you invest a large amount in a fund, then be in there for a long haul. 

3. Long-time returns and Low liquidity: Equity mutual funds won’t be able to bring you expected returns on your lump sum investments in a short time of one year. You need to give them at least three to five years or more to outperform your expectations. Also based on the same concept is the low liquidity factor. If you have low liquidity of funds, i.e. you are going to require your funds back in a couple of months or by the end of the year then you need not invest a large amount in equity mutual funds. It’s better to put your money in a debt fund like liquid fund or an ultra-short-term fund. 

4. Patience pays: The saying that patience is the most important virtue is the truest in this case. Equity funds are very volatile which is why their risk is high and the returns in them are high too. Thus, if your lump sum investments face a volatile market in short term you shouldn’t panic and let the fund rationalize so that it offers you good returns in long term.

5. Go Hybrid: It is understandable if you are not sure of the right amount of time for which to invest your lump sum investment in equity mutual funds. The solution to this problem is a hybrid mutual fund which has an STP (Systematic Transfer Plan). In a hybrid mutual fund, your investments are invested in a liquid fund or an ultra-short term fund where it is earning good returns but you can get the benefit of long term equity investments too with them through the hybrid fund STP system. STP systematically transfers a pre-determined portion of units from your liquid mutual fund/ultra-short term mutual fund to the equity mutual funds part of the portfolio. Thus it gives you the best of both worlds, investments in short-term funds and long-term funds both. 

Lump sum fund investments are better for long term mutual fund investments. The tenure for large investments shall ideally be as long as possible but at least three to five years so as to give the funds a time to stabilize and provide you good returns on annualized yields. If long term investments doesn’t suit you then it is better to invest in a hybrid fund or a debt fund or a liquid fund however if you are okay with putting in a large sum of money, which you may not need for a decade or so, in mutual funds units (i.e. in mutual funds provided by the fund house SBI mutual funds) then as per experts the returns of this large investment will be high because just like in real life, in the case of mutual funds too, fortune favours the brave.
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