No news seems good for mutual funds these days. Dividends now are taxable and interest rates are falling, which will drag down the returns from bond funds-the most sought after type of funds in recent times. Technology fund investors are still deep in the red. The oldest and the largest Indian fund, the US 64, continues to be in trouble.

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So, has the shine gone out of mutual funds-an investment tool in which Indians invested Rs 13,971 crore in 2001? The answer is an emphatic no. Investing is the art of matching the right investment for a time horizon with a defined objective. But often investing is thought of as some sort of a game. If the BSE Sensex gained 20 per cent and you earned 15 per cent, you have lost the game. But I think, the real measure of investment success is meeting ones goals. You will be a winner if you can ensure the right investment for yourself, your family and your financial goals.

Mutual funds remain the only financial tool with enough variety to meet most financial goals. Don't forget, the three fundamental strengths of a mutual fund-diversification, convenience and professional management-are still intact. This 3-in-1 benefit makes funds preferable to other investment options such as shares and bonds.

Diversity increases potential returns and decreases risk. Mutual funds allow an investor to spread out his money across as few as a handful to as many as several hundred companies at one time. Liquidity-the ability to readily access your money-is another benefit of mutual funds. Units can be sold on any business day at that day's closing price or at most the following day's closing price if the sell order is placed after the market had closed.

Professional management can be both a benefit and a liability of actively managed mutual funds. Several studies show that in the long-term actively managed funds have underperformed vis-a-vis the overall stock market. By picking funds with a good long-term track record, managers you trust and low expenses, investors can build a portfolio with a potential for steady, long-term returns that match their own investment goals and tolerance for risk.

Not all funds suit every investment need. Diversity also means different funds for different goals. Here are two thumb rules for aligning your financial needs with the choice of funds.

Low-risk investments: A case for bond funds

These are the funds for conservative investor seeking stable income with low risk of capital loss. They are particularly suitable for investors who don't have the money to adequately diversify with individual bonds. Aggressive investors too can benefit from investing in bond funds-diversification against the risk of equity ownership.

In the recent past, bond funds have proved to be particularly attractive. The average 12-month return on investment was 15.5 per cent as on March 18, 2001. The rate of return has been stable for some time (see chart) compared to returns on investment in equity funds. But such high returns are not sustainable. Though successive interest rate cuts in 2001 have helped a number of bond funds to post handsome gains, they have had a negative impact on the long-term return from these funds. The series of interest rate cuts has boosted the bond prices, hence the debt funds have gained in value. But the new money pouring into funds will yield lower return as the bond prices realign to the prevailing interest rates. The bond rally might prevail for a while boosting returns marginally. But realistically, over a longer time horizon, bond funds will yield only marginally superior returns than other fixed-income options, though with higher tax efficiency and liquidity.

Long-term Investing: A case for equity funds

A rupee saved is a rupee earned, right? Not necessarily. Thanks to inflation, over time that rupee could be worth less than when it was dropped into the piggy bank. To achieve long-term financial goals-be it your children's education or post-retirement income-you'll need to create a portfolio of investments that will provide sufficient returns after factoring in the rate of inflation.

In the long run, 20 years or more, stocks provide the best potential for returns that exceed the rate of inflation. While past performance is no guarantee of future results, stocks have historically provided higher returns than other asset classes. Identifying and exploiting market inefficiencies is the key to successful long-term equity investing. To do so, one needs skills and training to understand at least a few industries and companies, and think sensibly about valuations.

In my opinion one should not be investing in stocks if one cannot define any of the following terms: gross margin, operating margin, profit margin, earnings per share, costs of goods sold, dilution, share buyback, revenues, receivables, inventories, cash flow, estimates, depreciation, ammortisation, capital expenditure, market capitalisation or valuation, shareholder's equity, assets, liabilities, return on equity. To this list, I would add the flow ratio and return on invested capital. How many people are familiar with even these tools, much less the many others required to be a successful long-term investor?

Besides, I think picking stocks is going to be even more complex in the future than it has been. As Warren Buffett, the celebrated American stock investor, once said: "You can't tell who's swimming naked until the tide goes out."

The best way to balance the merits of equities being a compelling long-term investment vehicle with the risks of investing in individual stocks directly is to invest in equity mutual funds. The rupee cost averaging, whereby you can invest as little as Rs 500 every month, makes it all the more attractive saving avenue to build wealth.

Dhirendra Kumar heads the mutual fund tracker ValueResearch. He can be reached at valueresearch@vsnl.com