5 Steps To Wealth Creation Using Mutual Fund

All of us want to be wealthy but not everybody is interested in taking risk by investing in stocks. For such people, equities and equity-dedicated instruments, such as mutual funds, are much safer a bet. However, there are only a few, who could successfully create wealth for them through these instruments, despite equity being considered as one of the best asset classes to create wealth. People fail at it just because they do not research properly, do not develop an appropriate investment strategy, and moreover, do not stick to a strategy. Among others, lack of discipline is one important factor that detracts people from following a specific strategy for wealth creation, especially in case of direct equity.

Mutual Funds as Wealth Creator

In the current scenario, mutual funds are one of the potent ways to create wealth. The rise in the domestic mutual fund industry’s Asset Under Management (AUM) substantiates this fact implicitly. By September 30th, 2019, the mutual fund AUM increased to Rs.24.5 lakh crores from Rs.7.01 lakh crores on March 31st, 2013. The rise in equity dedicated AUM has been more spectacular than debt dedicated AUM and the main reason behind this is better returns generated by them in longer run. Some of the mutual fund schemes have generated returns in double digit for their investors in the last 10-15 years, even when the last one and half year was not very good for equity and equity dedicated mutual fund investments.

Let’s take an example of Canara Robeco Emerging Equities. This equity fund generated a CAGR (Compounded Annual Growth Rate) of 18.22 per cent in last 10 year ending October 11th, 2019, despite the negative returns generated by the fund in the last six months. Simply put, every Rs.1 lakh invested in this fund 10 years ago would be Rs.5.3 lakhs by now. In the span of these 10 years, the investment grew by more than five times.

However, pessimist may say that this does not include the great fall of 2008 and, hence, showing such returns.

So, here we take another fund with a longer history, Franklin India equity, which has witnessed a CAGR of 12.53 per cent in the last 14 years and every Rs one invested would have become Rs.5 by now. This return should be understood under the context of the usual disclaimer that the past performance may not be repeated in future.

Why Mutual Fund as Wealth Creator 

There are some benefits offered by the mutual fund as an investment instrument that you will not find elsewhere. It is an investment avenue, where investors are spoiled by choice. The mutual fund offers a wide range of investment opportunities, depending upon the risk profiles and preferences of investors. There are different categories of mutual fund schemes for investing in varied instruments, such as equity, government bonds, and corporate bonds. Some schemes are just for investment in equity, some are for fixed income securities only, and some for investments in both, equity and bonds. Hence, everyone can use it to invest and create wealth.

Apart from this, systematic investment plans (SIP) is one unique feature of the mutual fund, which makes the entire investment process very convenient. SIP enables 'rupee cost averaging', which means you can keep on investing a fixed amount at regular intervals, irrespective of market levels. This helps you in buying more units when the market is down and less when the market is up. It also assists you in aiming at larger corpus, even if you have very little to start with. Compounding, the eighth wonder of the world, what helps you achieve this and gives a multiplier effect to your investment.

Steps To Create Wealth through Mutual Fund

More than anything, what is important to create wealth is the time that you provide your investment to grow. The longer the duration the more the wealth you can create. For example, let us assume that you want a corpus of Rs.5 crore when you turn 60 years old. If you are at present and start investing immediately, you will need to Rs. 1,592 every month for the next 40 years to materialize your goal. However, if you plan to start investing after 20 more years, that is, when you are already 40, you would need to invest Rs.33,000 per month to achieve the same goal. This would be 20 times more than what you need to invest now. All these investments are assumed to be growing at a CAGR of 15% per annum. The total amount that you will pay in the former case is around Rs. 76,000. Whereas, in the latter case you need to pay Rs.79.2 lakh, more than 10 times of the sum that you would pay in the former scenario. What leads to such difference is the power of compounding. More than 50% of the growth comes from the compounding. Hence starting early is the key to create greater wealth.

For many, even after understanding the importance of early start, the situation is just not right. In such cases, the mutual fund gives you the option of SIP (discussed earlier) with a number of benefits. It is more like a recurring bank deposit scheme. This helps you to invest in your choice of the fund every month without any particular effort.

Do a Proper Research

A proper research cannot be undermined as you are putting your hard-earned money and, moreover, your future financial freedom at stake. Research acts as a strong support to your investments. Once you have assessed your risk profile, you can start researching funds that suit you and start investing in the selected funds. Historically, it has been witnessed that small cap dedicated funds have generated better returns than the large cap ones in the longer run. The more time you have the more risk you should take. Hence, considering wealth creation prospects, a good small cap fund may suit you better.

Nonetheless, if you do not want to research and want to keep your investment simple, index funds are also a good option for you. These funds invest in the same stocks and in the same proportion as any index. For example, BSE Sensex has generated around 16% annualized returns for investors over the last 40 years. Hence, ever Rs.1 lakh invested in S&P BSE Sensex in 1979 would have become Rs.3.84 crores today, giving returns of 384 times over the period of these 40 years.

Hold down fees

While doing your research, be wary of any mutual fund charging a management fee higher than the average of that category. One of the only few factors that have some correlation with future returns of a fund is the expense ratio. A higher expense ratio usually means lower future returns. The longer your investment horizon the greater impact of expense ratio on your future returns.

Never Chase Returns

One of the biggest mistakes made by any investor is switching funds all the time. If you see an asset class that is on fire, for example, infrastructure companies in the year 2007 or NBFCs in the year 2018, they try to ride that wave without realising its risk. We saw how the Bull Run in these sectors ended. If you want to grow your money for the long haul, do not switch your strategy every time you read the headlines.