Tuesday, October 7, 2008

Mutual Fund ...

Some observes that I put Mutual Fund in between FD and Stocks in my Pyramid.  So they ask why I jumped from Bankings Fix Deposit to Stock Market without talking about Mutual Fund first. 

No particular strong reason really, but my final proposal to Personal Finance is a bit related to Mutual Fund, so perhaps that's why I want to end the pyramid with Mutual Fund !?

Anyway, remember that bank has one special investment division just to buy shares to earn money.  Well, there are also company out there doing the same but not for the bank but for general public like us. Instead of receiving incoming money from Saving Accounts, mutual fund company receives investment money directly from us.  Then the money is used to buy the share of BEST companies in stock market.  Then the profit is share with all the investors.

So theoritically if Bank earns 12% and give you back only 3% in FD, 
then Mutual Fund company should be able to give you a return of 12% !!

People who work in Mutual Fund company need salary too.  So they get paid from the total pool of investment money too.  So you should get 12% return minus the cost of running such a mutual fund company.

There is only one minor correction.  Mutual Fund company does NOT receive money directly from you.  Because if they do, they may run away with your money without actually investing in stock market.  So to protect our rights, our money is actually given to a 3rd party called Trustee.  This Trustee is like a saving account in our names.  So it can only be paid out to us.  However, we also tell this Trustee that the Mutual Fund company we appointed can 'redirect' our money to stock market.  Therefore, Mutual Fund company invest our money without actually owning our money.

Remember I said all our money goes to bank ?  Well normally this Trustee is closely related to banks, if not already a part of them.

The brain of a mutual fund is the Fund Manager.  It could be one person or a team.  How good the performance of a mutual fund depends on how good the Fund Manager is.  Normally a mutual fund will buy 10-20 stocks.  So in a way, when you buy One mutual fund, your money is spread out to the 10-20 stocks that mutual fund buys.

So you may say, "so I diversify my investment even with only little money !!"

Sorry, Wrong again !!  That is still a convinient Myth about diversification.  One may argue its way to make above statement true but definitely not the Right way to perceive it in Personal Finance point of view.

When you buy a mutual fund, you buy the trust of the Fund Manager.  Basically you think that this particular Fund Manager can do as well as the bank and give you good return.  Once you trust him, that is counted as one !  No matter how much or how little money you put in, you trusted only One Fund Manager.  The Fund Manager may use your money to buy only one stock, it may buy 10-20 stocks.  Remember how the stocks are being purchased ?  They will always buy the BEST stock first, then followed by 2nd best etc.  So if you start with a very new Fund Manager, most probably he also start with only one stock.

So why bother mutual fund ?  Because buying mutual fund is easier and usually start with smaller amount of money.

1.  There are less than a hundred mutual funds to choose from while there are thousands of stocks.
2.  There are already many benchmark helping you to decide which mutual fund has done well in the past
3.  Mutual fund survives by having your business so they will proactively tell you what they do and why you should use their services.  Comparing to stock investment, the business owner doesn't really want to tell you their businesses strategy and master plan before it happen.  Mutual fund tells you up front what they plan to do with your fund.

Last tip is ... if you find a good Fund Manager, stick with Him, NOT the FUND !