Friday, December 9, 2011

3 Schemes you should "NOT" invest your hard-earned money

It's very easy for someone to answer where to invest. Ask a person, who has just started earning and he will also tell you dozens name like PPF, LIC, Fixed Deposit, stock market, mutual funds, neighborhood group committee scheme etc. He has heard these terms number of times at his home.

But can yau answer where NOT to invest money. Apart from those stocks where you've lost your money.

Let us discuss such schemes.

1. Index Mutual Funds: These are mutual funds where the fund manager invests all the money purely on companies contributing Nifty-50 or Sensex-30. This is called passive fund management as the role of the fund manager is very limited here. He can not enter or exit any company by his choice, irrespective of major fundamentals or technical reasons of the company. He follows index blindly. So, the benchmark of these funds is also Index of the stock market.

Although, these funds are able to generate profit, but for long-term equity diversified mutual funds will pay more returns. They also sometimes outperform or under perform index. The reason of under perform is basically because the fund manager has to keep some cash always to meet day-to-day expenses and redemptions. This is called tracking error.

The average active fund buys and sells stocks a lot more than an index fund. This results in a higher portfolio churn, which in turn has a direct bearing on expenses. So active funds have a higher expense ratio than index funds.

So, as far as index funds are concerned, lower expenses and index-linked returns are the biggest draws for the investor. However, while returns have been index-linked after accounting in tracking errors, lower expenses are an unfulfilled promise with most index funds.

2. Investments made on SMS : Now-a-days, we're getting SMS everyday (at least I'm sharing my experience), giving target price of 10%-20% upwards in few days. I've not subscribed to these SMS services, but somewhere around the world, someone is trying to help me, and that too free of cost. Strange.

Few months back, SEBI has also warned the investors to avoid these SMS's. Generally, it has been observed that certain stock brokers and promoters of the company are trying to manipulate the share price of their company and after sending SMS, many times a sharp rise has been seen on such shares. That gives the opportunity to promoters to exit from their loss-making shares to profit-making shares. And in this process, the small investors becomes trapped in net.

So, avoid these SMS. Do your own research. If you can't, just invest your money in equity diversified mutual funds.

3. Fund of Funds: A fund of funds (FoF) is an investment fund that holds a portfolio of other investment funds rather than investing directly in shares, bonds or other securities.

For the funds the downside is that expense fees for such schemes are higher that in the case of ordinary schemes since management fees have to be paid twice – since their cost structure will include the fees already charged by the funds in which the investments are made.

For the investor the problem is how the FoF structures its cost based on its expenses and how much will be passed on to the investor. They have to pay the management fees twice.

Another flip side – since the fund of funds is investing in a whole host of schemes which are themselves invested in a wide range of stocks it is possible – sometimes inevitable – that it will be investing in the same stock through the different schemes.

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