How to Become Crorepati using Mutual Funds

How to use mutual funds and disciplined investing over the years, to let compounding generate wealth over long term

Mutual funds are outstanding investment vehicles after you learn how to utilize them correctly. Most people, however, do not have a solid understanding or conviction about mutual funds.

The first absolutely essential point to understand is that the big money in mutual funds is always made by sitting through several business cycles. In other words, to reap large returns from funds, you have to have the strong belief and patience to sit tight for 10 or 15 years or longer. It's like real estate. You may not make anything if you buy and later become impatient or shortsighted and sell out after only three or four years. It simply takes time. Nervous Nellies are not good fund shareholders. Investors in open-end investment companies, as mutual funds are sometimes called, tend to buy the best-performing fund after it has had a huge performance year. The next year or two will probably show slower or poorer results followed by an inevitable economic recession. This is usually enough to scare out those with less conviction or the "I want to get rich quick" fund holders.

Sometimes shareholders will switch to another fund that someone convinces them is much safer (usually at exactly the wrong time) or has a "hotter" recent performance record. Switching breaks up your long-range holding plan. I suppose you should switch if you have a really bad fund or the wrong type, like an income or industry fund when you should own a diversified growth fund, but too much switching quickly destroys what must be a long-term commitment.

Bear markets can last from nine months to two years or more and if you are going to be a successful long-pull investor in funds, you'll need to acquire the courage and perspective to live through numerous discouraging bear markets. Have the vision to build yourself a great long-term growth program, and stick to it.

The super big gains from mutual funds come from compounding over a span of years. Funds should be an investment for as long as you live. Diamonds are supposed to be forever—well, so are your mutual funds. So buy right and sit tight, period!

How to Become a Crorepati the Easy Way

Here is what I regard as the ideal manner for a shrewd mutual fund investor to plan and invest.

Pick a diversified domestic growth fund that performed in the top quartile of all mutual funds over the last 5-7-10 years. It will probably have averaged an annual rate of return of about 15-20%. The fund should also have a better-than-average record in the latest 12 months when compared to other domestic growth stock funds. Steer away from funds that concentrate in only one industry or one area like energy, electronics, or gold. The investment company you pick does not have to be in the top three or four in performance each year to give you an excellent profit over 10 to 15 years.

When you purchase a mutual fund, you are hiring professional management to make decisions for you in the stock market. Most diversified funds should be treated differently from individual stocks. A stock may decline and never come back in price. That's why the loss-cutting policy (called Stop-Loss) is necessary.

However, a well-selected fund run by an established management organization will, in time, almost always recover from the steep corrections that naturally occur during numerous bear markets. This is because mutual funds are broadly diversified and should participate in each recovery cycle in the economy. Therefore, I believe an extraordinarily different strategy should be employed with mutual funds. Each time you get into the thick of an economic recession and the newspapers and TV tell you how terrible things are, why not add to your fund when it is off 25% to 30% from its peak price. It might even be a possible time to borrow a little money and buy more shares. If you are patient, within two or three years the shares should be up sharply in price. Remember, you're going to hold through many economic cycles, so why not be smart and add to your investment during each bear market?

You can also reinvest your dividends and capital gains distributions and benefit from compounding over the years. When you buy your growth mutual fund, you should make up your mind at the outset that you are positively going to sit through the next three or four bear markets or economic recessions. This will give you the maximum opportunity to make really big money.

How about Income from Funds using the Dividend Option?

If you need income, you may find it more advantageous not to buy the dividend plans of a fund. Instead, you could select the growth option of the best possible fund available and set up a withdrawal plan equal to 1.5% per quarter or 6% or 7% per year (=systemic withdrawal plan or SWP). Part of the withdrawal would come from dividend income received and part from your capital, but the fund should generate enough growth over the years to more than offset the withdrawal of capital, if it is limited to 6% or 7% per year.

There are many Asset Management Companies, such as Franklin Templeton, HDFC, DSP Blackrock and Reliance Mutual that offer a large family of funds with varied objectives. These families could offer you the added flexibility of making prudent changes many years later. These funds have been having a very stable management team over the last few years, with a good and consistent management style across funds.

How Many Funds Should You Own?

As time passes, you may discover a second fund you would also like to begin accumulating in another long-term program. If so, do it. At the end of 10 or 15 years, you might own a worthwhile amount of two or even three funds, but there is no reason to diversify broadly, so don't overdo it.

Those rare individuals with many crores could spread out in more funds which would allow them to place almost unlimited sums into a more diverse group of funds. If this is done, some attempt should be made to own different-style managers. For example, money may be spread among one value-type growth fund, one aggressive growth fund, one small cap fund, one global fund, and so on.

If you own a growth fund which, by definition, invests in more aggressive growth stocks, it should go up more in bull-market years and fall off more in price than the general market in some bear market years. This is fairly common and in keeping with the nature of most growth portfolios, so don't get alarmed and panic out at the wrong time. During the poor periods, try to look ahead several years. Daylight follows darkness.

When Is the Best Time to Buy a Fund?

Any time is the best time. You'll never know when the perfect time is and waiting will usually result in your paying a higher price.

Should You Buy a Global or International Fund?

Yes, these could be a sound investment and provide further diversification, but I would definitely limit the percent of your total fund investments. International funds can, after a period of good performance, suffer several years of laggard poor performance.

The Size Problem of Large Funds

Asset size is a problem with most funds. If a specific fund has huge amount of assets, it will be less flexible in retreating from the market or in acquiring meaningful positions in smaller, better-performing stocks. Therefore, I would generally avoid most of the very largest mutual funds. However, if you have a fund that has performed well for you over the years and it has now grown large but still performs reasonably well, maybe you should sit tight. Remember, the big money is always made over the long haul.

Checking Management Fees and Turnover Rates

Some investors try to evaluate the management fees and portfolio turnover rate of a fund. In most cases this nit-picking is not necessary. A good fund manager will sell stocks when he or she is worried about the overall market or a specific group, believes a stock is overvalued, or finds another, more attractive stock to purchase. That's what you hire a professional to do.

Why Many People Lose Money in Top-Performing Funds

Believe it or not, half of the people invested in some of the best-performing funds in the country may lose money. How can that happen? Very few people buy during a bear market. They're afraid. Far more people buy much later, during a bull market, when they feel much more assured. Some of these people then sell out over the next year or two when performance is slower or down. Why not buy and sit tight for the rest of your life and make a big fortune?

The Five Dumbest Mistakes Mutual Fund Investors Can Make

1. Failing to sit tight for an absolute minimum of 10 to 15 years.

2. Worrying about a fund's management fee, turnover rate, or dividends paid.

3. Being affected by news in the market when you're supposed to be investing for the long pull.

4. Selling out during bad markets.

5. Being impatient and losing confidence too soon.

To summarize, the way to make a fortune in mutual funds is almost always by your long-term sitting, not your thinking. If you purchase Rs 1,00,000 of a diversified domestic growth stock fund that is able to average about 15% a year over a period of many years, here is what could occur, compliments of the magic of compounding and time:

In 30-35 years, this Rs 1,00,000 will go on to become Rs 1,28,00,000

Now suppose you also only added 1,00,000 each year to your program and let it compound over the years and you also bought a little extra during each bear market while the fund was temporarily down from its peak 25%. What do you think you'd be worth?

So, in my opinion, faith and confidence in our long-term future is a very shrewd and intelligent position to take and stick with for as long as you live.

Modified from Advice by a book by [William O'Neil](http://en.wikipedia.org/wiki/William_O'Neil)