Convenience is the middle name of mutual funds one may not be exaggerating by saying this. Last month we have discussed what mutual funds are and some of the benefits offered to the investors. In this article, we will look at the convenience that mutual funds provide. This benefit ensures that mutual funds become an integral part of any individual's personal financial plan.

Let us look at these benefits. The first and foremost is the combination of very high transparency and easy liquidity. There is a category of mutual funds called open end funds, wherein an investor can invest or redeem any amount (subject to a certain small minimum limit) on any working day. As an investor can pull out money on any working day, the degree of liquidity is very high. Add to that the portfolio disclosures by the mutual funds. As per SEBI regulations, mutual funds are obliged to disclose the entire portfolio to the investors at a regular frequency. Most mutual fund schemes declare and disclose the entire portfolio on a monthly basis. On a monthly basis, an investor can see where their money is invested by the fund. In case the investor finds some difference between the scheme objective and the portfolio of investments, they can exercise their right to redeem their money on the very next working day.

These two features, according to us, are the biggest risk management tools for an investor. If something goes wrong, one needs to have the information as fast as possible. The information is useless if one is not able to utilise it to one's benefit. There have been many examples of investors losing money due to companies going out of business. Every few years, we have seen some of the co-operative banks closing down. We have also seen some large institutions or large companies encountering problems and the information reaching investors only after it is too late. That happens only because of the lag involved in the passage of information to the investor and the liquidity disappearing once the bad news is out. This is an area where mutual funds score over all the other investment avenues.

Another feature of mutual fund as a product is the unitisation of the investment. The money invested into a fund is converted into small units of the fund. In fact, an investor can also hold fractions of the unit. This allows an investor to invest (or withdraw) any amount of money large or small (subject to a small minimum limit) depending on one's needs. This facility makes investing in a mutual fund similar to operating a bank account.Over the years, as the product has matured, the investment advisors have packaged some of these features and devised some excellent investment strategies. These packages then help an investor match the cash flow with the investment account.

Let us look at two such strategies: Systematic Investment Plan (SIP) and Systematic Withdrawal Plan (SWP).Systematic Investing is a simple form of investing on a regular basis. For most investors the regular cash flows are on a monthly basis - be it salary or various household expenses. In that case, the net cash flow - the difference between income and expenses - or the savings also happen on a monthly basis. Hence, there is a clear need to have a solution to park this monthly saving somewhere. This is where mutual funds offer a systematic investment plan. An investor has to fill up one form and submit the same with multiple payment instruments (or instruction to one's bank for multiple investments). Then the mutual fund company takes over the entire administrative part of the process, i.e. handling the payment instruments, custody of the same, deposition in bank, sending information of transaction to the investor, etc. The investor has to only ensure sufficient balance in the bank account. While an SIP can be done in any mutual fund, it offers certain distinct advantages when done in an equity fund.

Equity as an asset class has two characteristics: one, in short periods of time, the prices of equity products fluctuate a lot; and two, over long periods of time, equity has the potential to create wealth by giving excess returns over inflation and taxes. SIP takes the advantage of both these characteristics of equity and works on two principles: the power of compounding and rupee cost averaging.

When one invests a fixed amount every month, one is able to turn the volatility of stock markets to one's advantage. Let us see how it works. An investor is able to save a sum of Rs. 3,000 every month and decides to enter into a systematic investment plan in an equity fund (let us assume there are no loads - We will discuss about loads later). As equity prices fluctuate, the NAV (Net Asset Value or the price of purchase) of the units of the equity fund will also fluctuate. However, since the number of units purchased would be inversely proportional to the NAV, every time the NAV is high, the investor would buy fewer units and when the NAV is low, the investor would buy more units. This will lower the average cost of buying the units.

Thus, systematic investing offers a direct benefit of matching an investor's requirement of managing monthly savings while also providing additional benefits of the power of compounding and rupee cost averaging. In this way, SIP works best to help an investor create wealth.On the other hand, if an investor has a need to fund his regular expenses from investments, he can opt for systematic withdrawal plan (SWP). Such an investor is likely to be a person who has retired from the profession and is dependent on investments. The ideal solution for such a need is to invest the money in an income fund and systematically withdraw the required sum as per the required frequency. This also happens through a single instruction given to the fund house.
To be continued

Amit Trivedi

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