Here are five commonly held beliefs about mutual funds that can cause you to make mistakes with them. Read on.
1) Buy from a fund house associated with your bank
Many of us are introduced to mutual funds by our bank. We have been customers of the bank for long time and are comfortable with it. These banks sometimes have associated fund houses.
To name just a few, ICICI Prudential Mutual Fund, HDFC Mutual Fund and SBI Mutual Fund are each associated with ICICI Bank, HDFC Bank and SBI. As a result many of us think that we should stick to the funds sold by our bank’s associated fund house because it will also be equally trustworthy and we will get a better deal.
The answer to both is, not necessarily.
Fund houses are run independently of the bank and the assets of mutual funds are held by a third party called the ‘Custodian’. As a result, if ICICI Bank becomes insolvent, this does not mean your holdings in ICICI Mutual Fund will become worthless and vice versa. These holdings are held separately and invested in a portfolio of stocks, bonds and golds of different companies depending on the type of fund you hold. The performance of your fund depends on the skill of the fund manager and movements in the stock and bond market rather than the quality of your bank.
With regards to getting a better deal, there are only two types of mutual fund plans – regular and direct. Investing through your bank means you will get the regular plan. The value of this plan (technically called NAV) will be the same for all investors. In other words, ICICI Bank customers in ICICI Mutual Fund get the SAME deal as SBI bank customers in ICICI Mutual Fund. As a result, investing in your bank’s associated fund house will not get you some sort of ‘loyalty benefit’ or better deal.
2) Only your distributor can deal with your fund
First-time investments in mutual funds are usually made through distributors. This could be your bank, a broker or an independent distributor. In return, the distributor gets a commission on the value of your fund every year (approximately 1% for equity funds and 0.5% for debt funds). As the years pass, you may need to do several things with your holdings. These could range from a change of address or bank account to selling the fund or switching to another fund.
Do you need your original distributor’s signature to do this?
No. You can get the relevant forms from the website of the fund you have invested in and directly submit them to the fund house. Your distributor will continue to remain in place, as long as you do not sell all the units of your fund. However you do not have to rely on him to get your transactions done.
3) You cannot change your distributor
This is incorrect. You can change your distributor at any time by downloading and submitting the relevant form at the office of the relevant fund house.
However there is one type of change in which you do not replace your distributor but simply remove him or her. This is known as moving from the regular plan of the fund to its ‘direct plan’ and which saves you the annual commission that is paid to your distributor. Doing this is considered as a redemption from your fund and hence exit loads and taxes may apply. However if you do this after a sufficiently long holding periods (one year for equity funds and three years for non-equity), the burden of exit loads and taxes will be minimal.
4) Your money is with your distributor
Your distributor may come to your house and physically take possession of your cheque. However the money will not go to him. The cheque is made in favour of the fund you are investing in. The money does not go the fund’s own account either. Instead, your money goes towards buying units in the fund which are assigned to you.
If your fund performs badly or goes to zero (although this is highly unlikely), you cannot recover the money from your distributor or the fund house. Investing in mutual funds means that you accept market risks including the risk of the fund value going down.
5) Invest with prominent fund houses because they are less likely to fail
While shopping for anything we often stick with famous brands because they bring an assurance of quality. For instance we might stick to Levis for a pair of jeans or Nike for our shoes. Does this work with fund houses as well? The answer once again, is not necessarily.
Your fund house going bankrupt does not automatically make your mutual fund units worthless because your funds are held separately by a third party called a ‘custodian.’ As a result investing through a small fund house does not increase the risk of your units going to zero. However brand strength may be an indicator of quality of management. Big fund houses may be able to afford better talent. However, there is little statistical evidence of this out there.