5 Signs That You are Gambling in Stocks cover

5 Signs That You are Gambling in Stocks.

“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” -Benjamin Graham

Gambling is not restricted to just casinos or horse racing. In fact, a majority of the investing population either speculate or gambles in stocks. However, similar to casinos where the odds are always in favor of house over the long run, gambling in the stock market also have similar results.

While investing in stocks, you should always remember that your returns should be commensurate with the risks that you are taking. If the risks are too high compared to the safety and returns, you are not investing, instead of speculating or gambling. A quick note, gambling is not the same as speculating. Gambling is speculating taken to an extreme.

The problem with too many people is that they believe that they are investing in stocks, but in actual they are speculating or gambling.

A typical example of gambling in stocks is people trying to make short profits from the minute market movements by trying to perfectly time the market. Unless you are trained to do so (like technical analysts), it is really difficult for the average investors to time the market precisely and repeatedly.

In this post, we are going to discuss five signs that may prove that you are gambling in stocks.

5 Signs That You are Gambling in Stocks.

1. Taking Free tips/recommendations:

If you are serious about investing in stocks and making money, either devote your time and learn the fundamentals or take the help of registered/certified investment advisors. Investing based on the hot tips or recommendations that you heard on a tv channel or from a colleague is a definite route to lose money. Most of the people who make consistent money from stocks are either do-it-yourself (DIY) investors or the ones who are smart enough to take the help of registered investment advisors. Yes, the advisors will charge you some fee. But consider it as the charge of calculated risk over the un-calculated ones.

2. Betting big money on short-term twitches in the market

Investing big money on the hot news that just read on the news website definitely doesn’t come in the category of investing. The future return from stocks is based on many factors which should be carefully studied rather than investing based on single news of a quarterly jump of EPS of a company by 40% or launch of a new hyped product. Serious investors should perform detailed qualitative and quantitative study rather than investing based on short-term market twitches.

Always remember the famous quote by Benjamin Graham- “In the short run, a market is a voting machine, but in the long run it is a weighing machine.”

It simply means that market psychology is hard to predict in short-term as sentiments drive it (similar to voting machine). On the other hand, long-term results can be measured concretely, if the studies are done correctly (like weighing machine). Focus on the long-term performance of the stocks, rather than short-term turbulence. 

Also read:

3. Putting all in a single stock.

Betting all your money in a single stock is the worst form of gambling in stocks. Maybe it seems a great opportunity now. However, there can be thousands of reasons which may prevent the stock from performing. And if that stock doesn’t perform as you wished, for whatever reason, all your hard earned money will be gone. Putting all in a single stock magnifies the risk. The wise approach for intelligent investors is to diversify their portfolio. As the old ones used to say- “Do not put all your eggs in one basket.”

Also read:

4. Using your emergency fund for short-term trades

An investor should understand the risk and reward. Investing your emergency fund to make short-term trades is a definite sign of gambling. After all, no matter how safe is the trade, you cannot predict the outcomes.  If things go wrong, you won’t have any alternatives if you have already used your emergency fund. As a thumb rule, always invest the money that is surplus.

5. Investing based on what big investors are purchasing

It’s challenging to understand the exact strategy of the big players of the market, no matter how carefully you track their investments. Moreover, a regular investor cannot match the resources available to big investors. Investing blindly in what big players are purchasing is undoubtedly a sign of gambling in stocks.

Also read:

Closing Thoughts:

Another way to find if you’re gambling in stocks is by figuring out how much emotionally involved you are. If you’re stuck with your phone/laptop screen throughout the trading hours, checking the stock price continuously, then you might be speculating. Moreover, if your investments are keeping you up all night, then you might be taking too much risk.

Anyways, speculation and gambling are not inherently wrong. Both have their own pleasures, benefits and a role in the financial world. The problem arises which people gamble in stocks and believes that it is a perfect investment. In such scenarios, people don’t know how much risk they are taking and whether those bets are even worth taking financially.

Choose the right Option

Choose the Right Option.

Can you build a long-term portfolio successfully with the help of short-term trading plans? Are you hedging it right?

Everyone knows that India, currently, is one of the finest markets to invest in. The major reasons being the current as well as forecasted economic developments, high returns on investment, increasing consumption pattern, growth prospects, political scenario and outlook, budget deficit and proposed infrastructural plans/projects. The long-term journey of India Inc. looks healthy, rewarding, and in good shape.

However, there are a couple of questions which come in the mind of every investor:

  1. How long is long term?
  2. What is the right time to enter the market?

The first question is correctly valid considering the changing business models, dynamic technological progressions etc. There are many business models which may become obsolete in a few years. Only a handful of companies, which can adapt to the dynamic environment, will survive.

Not to forget, As of 2018, only 7 companies are still part of the original Sensex 30 which was formed in the year 1987.

This entire critique revolves around the discussion for the second question. There are various macro factors affecting the overall market sentiment including market cycles of different time frames, economic cycles, political outlook and last but not the least, company’s stage of growth and development and its responses to the dynamic environment that needs to be considered while entering the capital market for a longer period of time. The most important thing to remember is one should invest in a business as against investing in a company.

short term long termAre investors capable of avoiding the short-term movements in the prices of the company’s stock? How does the investor’s mindset change in the bearish market? How can one capitalize such market scenario as well? How to maintain the balance between greed and fear? Can any investor actually time the market? What are the alternatives to be actively present in the market but not getting affected by the market dynamism?

Since the Indian equity markets made the record highs in the calendar year 2017 and 2018, each and every investor must have been waiting for the right entry point. Be it either by way of fresh investments (first entry in the capital markets) or by adding up to their existing portfolio. No one wants to enter the markets when they are just about the consolidate.

With the recent consolidation in the markets and their sideways movement, the fear of a consolidation phase continuing for the rest of the year in the Indian equity markets might be just around the corner for all investors. Although most of the Marquee investors, foreign financial institutions as well as the domestic Institutional Investors are very bullish on the Indian economy in the long run, they are contemplating a phase of consolidation in the year 2018.

One of the marquee investors, Rakesh Jhunjhunwala, even said that the incredible gains marked in the Indian capital markets in the year 2017 are bound to be abridged by some level of profit booking that could be seen in the calendar year 2018. After yielding stellar returns in the year 2017, everyone is expecting the markets to consolidate till the time the quarterly earnings increase to a level that could substantiate and corroborate the current price levels and high P/E multiples.

whats next

Here are some of the questions that we get to hear a lot from many of the investors;

  1. How to survive a falling / bearish market?
  2. Can investor do anything about their existing exposure to capital markets when the market sentiments are negative, prices in the forex market are volatile and the share prices are all set to nosedive?
  3. Will the recent default by the IF&FS group lead to a financial crash in India or is this just another case of a group that is Too Big to fail?
  4. How can an investor with an ‘All long equity’ mindset survive in the midst of rising capital market chaos, unveiling flaws with company’s management, high level of volatility and rising political turmoil?
  5. What should the investors do to their existing investment strategy and asset allocation? Should the investors look for a short-term shift from capital markets?
  6. With the likes of Yes Bank, DHFL and other NBFCs plummeting down to unexpected levels, is there something more to come?
  7. The auto sector companies are offering huge discounts to increase the volumes but still failing to meet the street expectations with the quarterly results and the monthly auto numbers. What should be the investor’s bet for this festive season?
  8. With the dollar appreciating against rupee and the rise in the oil prices, what can be expected from India Inc.?
bear market

Innumerable questions are on top of the mind of every investor succinct to one broad question –

What are the change/adjustments required in the trading / investing strategy of every investor in order to capitalize opportunities in the bearish market?

To summarize this, each investor is worried about their existing exposure to the capital markets fearing what can come up next to their stocks.

The alternatives available to all the ‘All Long Equity Investors’ are;

  1. The investor will have to sit on cash i.e. exit the existing portfolio; or
  2. Be in the market, earn negative returns on the stock portfolio and wait for the right time to average the holdings until the market has bottomed out.
facts

More than 9 months have passed in the year 2018 and we have seen a steep correction of up to 55 percent in small and mid-cap shares and up to 30-35 percent in some of the large-cap stocks as well. In fact, the broad market index – Nifty has also corrected in a double-digit percentage from the record high made in the year 2018 itself.

After all these discussions as well, there are institutions that are still making money. In a falling market, an investor can make money only by short selling i.e. sell at a higher value first and cover the position by buying the equivalent quantity at a lower price. However, equity markets (cash segment) do not allow the investors/traders to carry forward such a trade to the next day. i.e. the investor will have to square off (buy it again) the open sold position on the same day i.e. Intraday trade only. This is also known as entering a bearish trade. An alternative is to trade in options.

In a scenario where there are no clear opportunities/ideas for investing in specific stocks and earn money from equity markets (cash segment) as well as there are constraints of capital for investing into equities to average the cost of stocks, the investor should look to move to option trading.

The next question that comes to the minds of the investors is that with the constraint of capital, time and resources, how can an individual investor go on to take the additional risks of trading in option.

Options trading, if done with proper analysis and the right approach, are the safest bets that could yield the highest returns. Options trading is just perceived to be risky. Options are very powerful to enhance an investor’s portfolio returns. Option, if used wisely, can prove to be a perfect hedge to the existing exposure to the capital markets.

A popular example would be using options as an effective hedge against a declining stock market to limit downside losses. Options can also be used to generate recurring income (option writing, explained later in this article).

In the Indian derivatives segment, there are two main types of options – Call and Put. In case of strong bullish view on any stock, the trader may go for long-call option i.e. Buy call option. As against this, in case of strong bearish opinion for any stock, the trader may go for a long-put option i.e. Buy put option. Selling call options and put options trades are executed in case of week bearish or bullish interpretation respectively, on the movement of the stocks and it is primarily dealt to earn the share of premium and capitalize time value of money (Option writing, explained later in this article).

As explained, there are four coordinates to option trading – Long call, Short call, Long put and Short put.

call and put

Buying a stock gives you a long position. Buying a call option gives you a potential long position in the underlying stock. Short-selling a stock gives you a short position. Selling a naked or uncovered call gives you a potential short position in the underlying stock

People who buy options are called holders and those who sell options are called writers of options.

Also read:

Call option

A basic call option, in its meekest explanation, can be thought of as a down payment / token money paid for purchasing a house property in future.

For example: Whenever an investor decides to purchase a house property, he sees a new development going up. That person may want the right to purchase the house property in the future but will only want to exercise that right once those prophesied developments (let’s say, upcoming infrastructure road development project has been substantially finalized or a school has been built) around that area are built. These circumstances would affect the investor’s decision to purchase the house property. The potential investor would benefit from the option of buying or not (basis such developments). Imagine they can buy a call option from the developer to buy the home at say INR 10 lakhs at any point in the next three years. Naturally, the developer wouldn’t grant such an option for free. Such a payment is a non-refundable deposit. The total cost of purchase of the house property is INR 200 lakhs.

The investor needs to make that down-payment to lock in the right to purchase the house property at a future date within a stipulated time of three years.

Connecting the above example with the derivative markets, the down-payment no refundable deposit cost is known as the Premium. It is the price of the option contract paid by the investor to acquire the right to purchase at a future date. The investor is said to have gone long the call option. The total cost of the house property fixed between the investor and developer of INR 200 lakhs is the contract price of the option contract. It means that irrespective of the market conditions, the investor has the right to purchase the house property within a period of 3 years at a fixed price of INR 200 lakhs.

Let’s say, two years have passed, and now the developments are in line with the proposed plans of the area and zoning has been approved. There is no garbage dump that is coming nearby; School and road projects, as forecasted, are up and running. The investor exercises the option and buys the home for INR 200 lakhs, as agreed earlier. The market value of that home may have increased multi-fold times to, let’s say, INR 600 lakhs because of all the developments in that area. Nonetheless, the investor has the right to purchase the house property a pre-determined price locked in at INR 200 lakhs only.

Since the value of the underlying asset increased, the call option buyer benefited from the transaction.

Now, in an alternate scenario, say the zoning approval doesn’t come through until year four or the school which was proposed to be constructed, did not come through, and the market price of the house property falls to INR 100 lakhs. The investor will not want to exercise his right to purchase the house property since he is getting it at a much discounted price from the market. The down payment paid shall be, obviously, forfeited by the developer.

The main advantage of going long (bullish trade) with a call option is that the maximum loss shall be restricted to the amount of premium paid to enter into the contract keeping the potential upside of the profit open. To simplify, the investor can gain from the up-move of the stock without purchasing the stock. The huge capital required to purchase the stock is no longer required because the upfront cost is limited to the amount of premium.

Selling a call option (Short call)

The above example was the case when the investor purchases options i.e. get the right but no obligation to purchase the underlying asset. Let’s look on the other side of the coin. What happens when the individual sells options instead of buying? What are the rights and obligation of the other party to the contract?

This phenomenon is called option writing (option selling). In such a case, the option writer will have the obligation to deliver the underlying asset on the date of expiry of the contract, if the option buyer exercises the right in the option contract.

Continuing the above example of making payment of the token money/down payment to purchase the house property on a future date at a predetermined contract price. The developer who receives the token money is known as the option writer. He is obligated to sell the house property at a predetermined fixed rate of INR 200 lakhs (as per the contractual terms), irrespective of the actual market price of the house property at the time of exercising (after 3 years).

To summarize, if the home buyer does not exercise his right, the down payment (known as the premium) received shall be the income of the developer.

Put options

A put option can be thought of as an insurance policy against any asset. It is to protect the downside risk of the asset owned (securities). For example, the investor foresees a fall in the prices of the broad equity index of close to twenty percent in next six months because of the best reasons known to him. However, the investor does not want to liquidate its exposure in the equity markets because of the long-term positive outlook. To avoid the short-term losses because of the increased volatility, the investor can hedge its existing exposure to the equity markets by entering into a put options contract. A long-put option contract is a bearish trade which works like an insurance policy against the underlying asset. A long-put option gives the investor the right to sell the underlying asset at a predetermined price for a specific period as per the options contract.

Even if the value of his shares become zero, the investor can exercise his right to sell at a fixed price determined at the time of entering the options contract.

Needless to say, purchasing such a right to hedge the downside risk of the underlying asset has to come with a cost. This cost is known as the premium of the option. Similar to the long call option, the maximum loss on the long-put option contract is limited to the amount of premium paid to acquire the right to sell the underlying shares.

If there are investor hedging the downside risk of the underlying asset, there has to be someone who ensures such downside risk. With that, we come to the last co-ordinate of option trading i.e. writing put options. Continuing the above example of insurance contracts, the insurance companies which are receiving the amount of premium are known as put option writers. The put option writers are obligated to purchase the underlying asset in case the put option buyer exercises his right to sell the underlying asset.

This works exactly similar to call options where the maximum loss for the put option buyer is limited to the amount of premium paid as against the maximum loss for the option writers is limited to the total value of the underlying asset (the price of a stock can fall maximum till zero).

Now the real question which most of you might have;

Why would anyone opt for writing options as against buying options? Option writing has more risk and limited profits (limited to the amount of the premium received). As against this, option buying has a limited risk (limited to the amount of premium paid) and unlimited profits (the upside of the stock is unlimited)

The answer to this question is also very simple. How often do you see exercising an insurance policy within the stipulated time period? How are insurance companies surviving since their entire business revolves around offering safeguards against losses?

That’s correct, the major revenue stream for any insurance company is by way of the premium received. Most of the policyholders do not exercise the insurance contracts within the stipulated time frame and forgo the amount of premium.

The maximum liability of the insurance company is unlimited to the extent of the amount of loss. The maximum profit shall be the amount of premium. However, no one talks of the probability of winning as an option buyer. Option seller, on the other hand, is operating with a very high probability of winning (discussed later in the article).

To summarize, call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights. This limits the risk of buyers of options to only the premium spent.

Call writers and put writers (sellers), however, are obligated to buy or sell if the option expires in-the-money. This means that a seller may be required to make good on a promise to buy or sell. It also implies that option sellers have exposure to more and in some cases unlimited, risks (theoretically). This means writers can lose much more than the price of the options premium (again, theoretically).

How is the derivatives segment in the Indian capital markets different from the above examples, practically? Does the Indian capital markets offer a physical settlement of the underlying asset? Can the contracts be settled before the stipulated time period in the contract?

options trading

Theoretically, this is exactly how any option derivative would function in a hypothetical scenario. However, practically, the Indian capital markets do not offer a physical settlement of the underlying stocks. Instead, the contract is always cash settled i.e. the amount of benefit to the option buyers or option sellers derived from the underlying asset is reflected in the price fluctuations of the premium of that option contract.

Continuing the above example of the right to purchase the house property within three years, with every passing year and the development of that area, the cost of purchase of the house property will increase. Such benefit from the increase in the purchase cost of the house property will be reflected in the amount of premium to be paid to acquire the right to purchase after the stipulated number of years. Initially, the investor paid INR 10 lakhs to acquire the right in year 0. Post the developments, the premium might have increased to INR 30 lakhs in year 2 apprehending the increase in the total cost of purchase of the house property.

Practically, in the derivatives capital market, the investor can sell the premium at the end of year 2 at the market price and the difference will be the profit. This is known as Cash settlement of option contracts. Although the contracts are settled only on the expiry of the contracts, the parties to contract can square off their existing exposure to the option trades with other market players. The difference between the buying and selling price of the premium amounts will be the payoffs for the investor from that trade.

Now the next question that comes to every trader’s mind is that which strategy should be opted?

options contract

There are four co-ordinates to option trading having two possible views – bullish or bearish. For example; most of the option traders are confused between ‘selling a call option’ and ‘buying a put option’. Broadly both are bearish strategies. Buying a put option is preferred when the trader expects a weakness (steep fall within the stipulated contract period) in the stock. As against this, selling a call option is preferred when the trader expects no further upside for that stock. In a scenario when the stock is stable through the period of contract, the option seller still earns the amount of premium because of the element of time value in the option. Most option writers capitalize this time value premium in every option price. Option writing should be used as a hedging total as well as to reduce the total cost of buying the option.

In my opinion, option writers tend to earn more than option buying. Selling options, whether calls or puts is a popular trading technique to enhance the returns to the entire portfolio.

If the trades are executed with precision, proper analysis and patience, the trader definitely earns anywhere between 5 (on the minimum) to 25 percent month on month.

To support this view, reliance is placed on a study paper by Dr. John F. Summa which was published in 2003 in Futures Magazine. In his study, Dr. Summa finds that, regardless of the market direction and market sentiments, option sellers have an advantage over option buyers. Based on his study of expiring and exercising options covering a period of three years, an average of 76.5 percent of all the options held till expiration expired worthless (out of the money). The same has been tabulated as under;

dr john summa result

On this general level of information about option trading, we can conclude that for every option exercised in the money, there were three options expired out of the money and thus worthless. Therefore, option sellers had better odds than option buyers for positions held till expiration. Even though the study paper was submitted 15 years ago, not much has changed in the context of capital markets except the price of the stocks.

In addition to these, the option buyer is said to operate with limited risk and an opportunity to gain unlimited reward. But no one talks of the probability of winning as an option buyer. Option seller, on the other hand, is operating with a very high probability of winning.

Further, in such a market where investors are fearful of investing more money to the markets and increase the exposure, an option seller can use collateral and need not bring in funds. Further, the seller has the flexibility of hedge his position using the same collateral. As against this, an option buyer has to bring in capital to buy the option.

Even though the statistics and probability backs option writing over option buying, it requires immense precision, diligent thinking, and meticulous monitoring.

To conclude, I would just like to quote PR Sundar’s words in one of his interviews, ‘Option selling is like sitting in front of a bonfire. If you are too close, you can get burnt. If you are sitting too far, then you will not enjoy the warmth. You need to sit at the right distance from the fire’.

Applying the analogy in option trading, If you are trading close to the market price, then the risks will be higher i.e. risk of the strike price so traded, being in the money at the time of expiration). If you are trading a strike price which is too far away from the current market price of the underlying asset, the reward (the amount of premium) will be low as will be the risk of that trade. It is the flexibility, hedging advantage and the probability of success that option trading offers that makes it a very attractive tool to indulge into.

Have a good day! Happy Investing! Happy Trading!

Note: This article is written by guest-author ‘Pranav Thakkar’ and also posted here.

buyer's remorse cover

What is Buyer’s Remorse? And how to deal with it?

What is Buyer’s Remorse? And how to deal with it?

Have you ever bought a new pair of shoes that you’ve been planning to buy for a while, but started regretting the purchase as soon as you arrive home? Maybe it was the best deal in the last three months, and you got a discount of over 30% on the original price. Still, you can’t stop thinking that you might have overpaid for that shoe. Or you might start presuming that you didn’t need a new pair of shoes at all and you have wasted the money on it ‘unnecessarily’.

This regret after purchasing a product is called a buyer’s remorse. And don’t worry, you are not different. It happens to everyone.

Nevertheless, purchasing commodities are not the only thing where people feel “buyer’s remorse”. Stock investors are also like ordinary people, and they too feel the buyer’s remorse after purchasing equities. Anybody who has been in the market for a long time might have already experienced investor’s remorse.

In this post, we are going to discuss what actually is buyer’s/investor’s remorse and how one can deal with it.

buyer's remorse pic-min

Investor’s Remorse

Investors sometimes feel remorse when they make investment decisions that do not immediately produce results. The guilt is more prominent when the share price starts going down.

Here are a few general questions that come in the mind of every investor in such situations:

“Was buying this stock a mistake?”

“Was my timing right?”

“Did I just buy a lemon of a stock?”

“Is the market going to collapse?”

“What if I lose money?”

Moreover, the investor’s remorse become stronger when people watch the latest news. The TV analysts/anchors make the current facts (which were not available at the time of investment) look so obvious that people start regretting their decisions at once. However, it is always easier to see into the past than to estimate the future. As Warren Buffett used to say:

“In the business world, the rearview mirror is always clearer than the windshield,” -Warren Buffett

There’s a very fair chance that you might have taken the best decision based on all the available information at the time of your investment.

Also read:

Buyer’s Remorse Effects

In general, there can be two effects of the buyer’s remorse.

  1. Impulsive decision to return (or sell) the product which may be well reasoned and a smart idea in the first place.
  2. Justifying the investment and refusing to accept the mistake.

Both these effects can be adverse for the investors.

Leaving your position in a well-researched stock just to get over the guilt is never a good idea. On the other hand, becoming adamant on your investment decisions may be damaging for your portfolio and will prevent you from learning a valuable lesson.

Ways to deal with Buyer’s Remorse:

The best way to deal with buyer’s/ investor’s remorse is to re-examine your purchase (both risks and opportunities).

Stand with your stock if the fundamentals are the same and the reasons for purchasing that share is still valid. On the other hand, if you made a mistake, then fix it.

Here are two additional ways which can help you to avoid buyer’s remorse:

  1. Avoid impulsive buying or selling: It’s always a better approach to research intensely before buying or selling. Taking an informed decision will build confidence towards your investments, even if they do not show short-term results.
  2. Have a margin of safety (MOS): If the calculated intrinsic value of a stocks turns out to be Rs 100, then give your calculations a margin of safety of 20–30% and purchase the stock only when it is trading at a price below Rs 70–80. Having a MOS while buying shares will mitigate the risks and safeguard your investments. (You can use Trade Brains’ online calculators to find the intrinsic value of the stocks).

Final tip– Always remember that buyer’s remorse is natural and inbuilt human psychology. But acting or reacting to this guilt depends on the person. The ability to handle buyer’s remorse will make you a better investor.

how to mutal funds make money trade brains

How Do Mutual Funds Make Money?

How Do Mutual Funds Make Money?

Ever seen the “Mutual Funds Sahi Hai!” ads? Have no idea what we are talking about? Check out the ads here!!

We, at Trade Brains, happen to see a lot of these advertisements. In fact, we even love them because although comical and mere advertisements and these ads educate the public about mutual fund investments in a more touching way than what we could ever do.

(Source: Mutual fund Sahi Hai)

But those of you who have seen these ads must have wondered for a long time about how these guys make money? Why give so much wealth away for free? After all, economics says that there are no free lunches, right?

Well, to be honest economics is right. There are no free lunches and mutual funds are not free. This post is aimed to provide a basic insight into answering the above questions. Here are the topics that we’ll cover in this post:

  1. What are mutual funds?
  2. What are the sources of revenue for a mutual fund?
  3. The different costs involved in running a mutual fund.
  4. Industry trends and closing thoughts

Overall, it’s going to be a very interesting post for the mutual fund enthusiasts. Therefore, let’s get started.

1. What are mutual funds?

Mutual funds are investment vehicles managed by professionals that seek to pool investments from many people together before investing them into markets within the financial ecosystem such as equity markets or debt market or a hybrid of both debt and equity. These vehicles are normally managed by professional fund managers or are programmed to follow certain broad indices pertaining to a certain industry or a country.

In general, mutual funds are thought to be best platforms for investors to get the benefits of capital appreciation from the equity markets even if they are not confident to manage their own money in the markets or if they are not able to dedicate time for their own research.

Some retail investors who invest on their own also happen to invest mutual to provide some diversification in their portfolio or reduce the volatility of returns since a lot of the times retail investors tend to have a concentrated portfolio of around 8-20 stocks.

Also read:

2. How Do Mutual Funds Make Money? And what are the sources of revenue for a mutual fund?

The biggest source of revenue for mutual funds is usually the fees that they charge from their investors. This usually comes out in the range of 1.5%-3% of the assets under management. This is commonly known as the expense ratio. Here is the example of the expense ratio for a few popular funds:

expense ratio

However, as of September 2018, it has become legally binding for mutual funds to limit their total expense to 2.25% of the total assets under management. 

References:

The other sources of revenues for a mutual fund come in the form of exit load, front loads, and purchase fees etc. (Also read: 23 Must-Know Mutual fund Terms for Investors.)

3. What are the costs involved in running a mutual fund?

Since most funds hire analysts in research positions a good chunk of the revenues is spent as salary expense for most mutual funds. Other expenses include rent of office and facilities, administrative expenses, payments for research material from data sources etc.

The other major expenses include brokerage fees and transaction costs, costs, investment advisory fees, and marketing & distribution expenses.

4. Current Industry trends

Since this industry is very competitive it can be said that when it comes to profits being the industry tends to follow a bell curve with close to 50% of fund houses making a profit in a year. But lately, the trend has been that some firms also generate profits not from their core operations but also by providing research and analytics to clients based offshore.

Another interesting observation to be made is that fund houses which operate a number of mutual fund schemes tend to have higher profitability than their peers. This is due to the fact that a lot of the core setup required for research and administration is pretty much in place and doesn’t need to be set up from scratch each time a fund house launches a new scheme.

Also read:

Closing Thoughts

Investors in mutual funds could protect their investments if they were to invest in safe fund houses which can generate a decent return from the market even during the worse days. Since it is nearly impossible to get an idea of profitability among mutual fund players, investors could use the financials of the parent companies as a proxy. 

Nevertheless, as always, mutual fund investments are subject to market risksPlease read all scheme-related documents carefully before investing.

New to mutual fund investing? Want to learn how to pick the best mutual funds? Then, check out our online course- Investing in Mutual Funds? A Beginner’s Course. Enroll now and start your journey in the exciting world of mutual fund investing today. #HappyInvesting.