Millennials must save and invest in mutual funds

Young people are constantly badgered by their older relatives to save more. But socking away money is not easy when everybody around you is spending lavishly and having fun.

The fear of social opprobrium and peer pressure are key reasons why millennials prefer to spend today than save for tomorrow. If they want their future to be financially secure, millennials need to save and invest more diligently.

Mutual funds are perhaps the best way for young investors to get started on their investment journey. They offer everything that one looks for in an investment--stable returns, diversified portfolio, low costs and ample liquidity. Whether one wants to save for a short-term target or accumulate for a long-term goal, mutual funds can be used to reach those milestones.

The other big advantages of mutual funds are the low ticket size and ease of investment. One can start off with as little as Rs 5,000. Now that the e-KYC procedure has been allowed once again, one can go online, fill out an application form, upload the required documents and start investing. Millennial investors, who usually hate cumbersome paperwork and seek convenience in online procedures, will love this.

Choosing the right scheme

This is a tricky area, especially if you are new to mutual funds. A large number of schemes across different fund categories can be mind-boggling. Don’t get swayed by the short-term performance of some funds. The stability of the performance is more important.

A fund may not be the top-performing scheme this year but if it has consistently given good returns for several years, it would be worth investing in.

On the other hand, the best performing scheme in the past 12 months may not be the best option if it took too much risk to generate those returns. Many mutual fund websites and portals assign star ratings to mutual funds on the basis of their long-term performance record and risk-adjusted returns.

These ratings can be useful for separating the chaff from the grain. Take the help of a qualified investment advisor or a fee-only financial planner if you are not able to make up your mind.

Don’t buy too many funds Diversification reduces the risk and brings stability to a portfolio. But some investors tend to overdo it by investing in too many funds in the attempt to diversify their holdings. It is not uncommon to see portfolios with 18-20 schemes.

Holding too many funds per se will not hurt returns, but it will make the task of monitoring and reviewing the portfolio difficult. As a result, the investor may not know that he is holding underperforming schemes, which will bring down the overall returns. Besides, buying funds from the same category only duplicates the holdings, and doesn’t diversify the portfolio.

One should invest in not more than 4-6 equity funds from different categories. That can give the portfolio all the diversification it needs. Equities are inherently volatile and stock indices never move in a straight line. This is why mutual fund investors should take the SIP route to avoid getting caught on the wrong foot. If you invest a large sum at one go, you could suffer losses if the market suddenly moves down.

On the other hand, SIPs help average out the price over a period. But keep in mind that SIPs are only a mode of investment, not an investment option. They can help average out the costs but there is no assurance of capital protection. If markets do well, SIP investments will obviously give good returns. But if stock prices recede, there is no way the SIP investor will be able to avoid losses.

Though SIPs can help build wealth, some investors get overwhelmed by market volatility and redeem their investments too soon. Stopping SIPs when markets are down defeats the whole purpose of systematic investing. Start a SIP only if you want to remain invested for the long term (at least 5-6 years).

Invest in debt funds too

All investors have short-term goals as well. While equity funds are appropriate for long-term goals of more than five years or so, debt funds are useful for short-term goals, such as an overseas holiday or an expensive gadget.

A debt fund will give you greater flexibility and better tax efficiency than bank deposits. But debt funds can lose money if interest rates go up or if the bonds in their portfolio are downgraded. When rates go up, the value of the bonds held by the mutual funds goes down, and vice versa. Funds holding long-term bonds are more volatile but short-term debt funds holding bonds with a maturity of 1-2 years are not very sensitive to interest rate movements.

(The writer is Founder and MD, MyMoneyMantra.com)