As the stock market has gone up, so has the frequency with which mutual funds have launched new schemes. It is easier to sell new mutual fund schemes to investors when the markets are doing well in comparison to when the markets are not doing well.
A lot of investors get out of their existing mutual fund schemes to invest in new mutual fund schemes that come along. The primary sales pitch such investors fall for is 'You will get more units.'
But having more units doesn't really make a difference and it can even work against the investor.
Let us see how this sales pitch works. Say, an investor has 511.5 units of a scheme whose current net asset value (NAV) is Rs 20. So the total value of his investment is Rs 10,230 (Rs 511.5 x 20). A mutual fund distributor approaches this investor and asks him to invest in a new scheme whose new fund offer is currently on.
So the investor sells out of the existing scheme and gets Rs 10,230, which he invests in the new scheme. In a new scheme, units are issued at a price of Rs 10. Other than this there is an entry load of 2.25% for the retail investor. 2.25% of Rs 10,230 works out to Rs 230, and this is paid as the entry load.
The remaining Rs 10,000 (Rs 10,230 - Rs 230) actually gets invested. Against this Rs 10,000 the investor gets 1,000 units. So, as we see, the number of units nearly doubles and the investor is really happy about it.
But what difference does it make?
Let us say the scheme the investor originally was in and the scheme the investor is in now, make the investment in the same set of stocks. One year down the line, these stocks give a return of 25%. So the NAV of the original scheme has gone up to Rs 25 (Rs 20 + 25% of Rs 20). The total value of his investment in this case is Rs 12,787.5 (Rs 25 x 511.5 units).
In case of the new scheme the NAV of the scheme after one year is Rs 12.5 (Rs 10 + 25% of Rs 10). The total value of the 1000 units the investor has in this case is Rs 12,500 (Rs 12.5 x 1000 units). So even though the schemes have performed equally well in both the cases, the investor loses out by moving onto a new scheme because he pays an entry load and hence a lesser amount of money gets invested.
Hence, he would have been better off had he stayed invested in the old scheme.
What really matters at the end of the day is the stocks the fund manager invests in and not the number of units an investor owns.
Given this, it always makes more sense investing in schemes which have a certain track record in the market and not in any new scheme that comes along.
Now comes the bigger question of why do mutual fund distributors make this selling proposition, even though it is not in the best interest of the investor. The answer lies in the fact that no broker has ever made money by letting his investors stay on to their investments.
Similarly, a mutual fund distributor makes a trail commission of around 1%, if the investor continues to stay invested in the scheme. On the other hand if the investor invests in a new scheme the distributor is likely to make 2-4% of the amount invested as commission.
It is simple economics which is at work here. Also an investor has a limited amount of money to invest. Every time a new scheme comes along, an investor need not have more money to invest in it.
So the simplest way out for a distributor is to get an investor out of an existing scheme and get him to invest in a new scheme.
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