How to invest without using mutual funds

Published: August 24, 2020 at 11:52 am

Investing in mutual funds is only a choice and has nothing to do with “financial literacy”. Imagine yourself as a financial advisor with no conflict of interest – meaning you are neither a sales guy nor looking to profit from a percentage of a clients networth. A client comes to you and says, “I want to invest for a long term goal but will not invest in mutual funds”. How would you suggest products?

To assume a person has become financially aware or literate simply by choosing mutual funds is like saying if you hold a cricket bat like Sachin, you could become one. Thanks to effective propaganda by AMC folk and irresponsible journalists, such a notion has entered into public consciousness. See: Product Pushing, thy name is financial literacy!

Financial literacy has only three simple tenets: (1) protect the family with at least life and health insurance and adequate emergency fund (2) avoid unnecessary debt (3) recognise the impact of inflation and invest (therefore spend) accordingly. That is it. Read more: A syllabus for financial literacy and conflict of interest

Anyone who appreciates this is financially literate. How they choose to implement this is up to them. Every choice has a set of pros and cons. It is only a matter of appreciating the cons either before putting in money or after. Facebook group Asan Ideas for Wealth Members would know this as “earn money or experience” via its admin, Ashal Jauhari.

Now, a financial advisor with no conflict of interest is expected to be a fiduciary – have their clients best interests in mind all the time. The client does not want to invest in mutual funds. Where else can they invest?

Real estate is illiquid, not transparent, needs leverage (loan) and a low yield product with several difficult-to-surmount risks like building quality, legal issues, logistics etc. So that is rejected. Read more: Five reasons why I will never invest in real estate and Avoid Real Estate Investment Trusts (REITs) & InvITs! FAQ on Basics

ULIPs are mutual funds with interlinked insurance much more expensive than a term plan. An investor cannot exit a poor performer without losing insurance benefits. So that is out. Read more:  ULIP Returns vs Mutual Fund Returns: A Comparison and Do not buy ULIPs because equity mutual fund LTCG will be taxed!

NPS is a mutual fund, so they are out (for retirement). In any case, they are illiquid and rather unreasonably states that if a person exits a day before she turns 60, 80% of the corpus has to be locked away.

Gold is simply too volatile and too unproductive to be the core holding of a long-term portfolio. Since gold ETFs and gold funds are out and Sovereign Gold Bonds unsuitable for portfolio management it is better to assume gold exposure is nil for our “client”. All chit funds, high-interest fixed deposits are out as their risks are invisible and could hit all of a sudden.

If a person wants to avoid equity mutual funds, the alternative is straightforward, direct equity. As you read this, some of you may be thinking, “but direct equity requires discipline, time, expertise and riskier”. That is the result of efficient AMC propaganda via its sale guys and media connections.

Sure, direct equity has additional obstacles like concentration risk, emotional biases and additional tax on churn, but they are not insurmountable. The problem arises when we start asking, “which is better direct equity or mutual funds?” and assume a definite answer can be found. Only a mutual fund sales guy can answer this without batting an eyelid.

Other than anecdotal evidence of big gains or big losses from either choice, no one can say which is a better choice. It is up to the individual and we will know only after considerable time and money have been spent.

Assuming we avoid a PMS (or thankfully we cannot afford one as yet), a simple direct equity portfolio can be created by replicating the Sensex (30 is easier than 50) or by choosing stocks with low absolute volatility (standard deviation) and low relative volatility (beta) from the Nifty 50 and Nifty 100.

Yes, it requires discipline, conviction and focus. What does not? It is not as if MF investors do not need these? Most MF investors are clueless about how to choose and how to manage a fund portfolio. It is not as if they are going to be worse off if they switched to direct equity. At the very least, there is no way to tell! And those with “advisors” have one fund too many because all AMCs have to be “pleased”. So most active fund investors are anyway index investors anyway (regular plan or direct plan).

Yes, direct equity has its own set of challenges but those who are willing to pay the price of their choice can in principle pull it off.  We now have stock baskets (like small case) to even automate this, as long as a prudent selection is made. High-churn baskets can be trouble here. So caveat emptor. Read more: Smallcase review: What you need to know before investing

Mutual fund investing is only a choice. To assume it is the best choice and it automatically makes a person financially literate is delusional, to say the least. Like all choices, it comes with its set of pros and cons. An active fund is at the mercy of the fund manager and fellow investors (like we learnt in the case of Franklin). An index investor is betting on just a few stocks and is likely to have a more concentrated portfolio than most direct equity investors.

All our troubles start when we assume there is only one good choice and our money needs to be in it. Personal finance is simply too personal to identify winners unless there is a conflict of interest involved.

We are getting ahead of ourselves here. What about the debt part of the portfolio? No debt funds here. Endowment and money-back policies are too expensive and low-yielding. So they are out. Buying govt bonds is an option but not amenable to regular investing.

The options are reputed recurring deposits, fixed deposits, flexo-deposits, PPF, EPF(or VPF in spite of its interest payment track record) and small saving schemes. Nothing new, most Indians anyway use these regularly. The price to pay is lower liquidity, higher churn, reinvestment risk (lower rates on maturity) and higher tax (in fixed deposits).

If you stop to think about it, unlike an equity fund, a debt mutual fund provides a basket of securities that a typical retail investor would have difficulty or hesitation in accessing. With their tax-efficient status (compared to an interest-based fixed income product) a debt fund is more valuable than an equity fund when it comes to down to choices. Unfortunately, they should not be selected like equity funds – based on past performance!

I have a singular point to make. Mutual funds are only a choice. They are a good choice only to those who put in the effort to appreciate risks. Putting our money in MFs will not make us smarter or financially literate. An investor can avoid mutual funds and happily reach their financial goals. Every choice has a cost, a con and a pro. It is a matter of what is acceptable to each investor. In fact, even equity investing is just a choice. Also see my ETWealth piece: Why investing is not only about equity

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About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
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