Mutual Fund is a Smart Investment option, So use it Smartly

Mutual Funds are for everyone and for anytime, here we can invest for one day (in liquid funds) to 20 years (in equity funds) and from as little as Rs. 500 to as much as Rs. 1000 crores. However investors still get confused sometime like: when to invest or when to redeem or what is the best time to start a SIP or should one stop the SIP when markets are not good. Some investors have doubt regarding the category of funds, like – Why not invest in sectoral or small cap funds (as their past performance is quite attractive) in lieu of Diversified Equity Funds or Large Cap Funds. Some investors are curious that is it wise to start SIPs in schemes with large corpus as they doubt that the current performance may or may not be sustainable in future due to the size of the fund. Let us try to fund out the rationals and logics to make this smart investment options work smartly for us.

Mutual Funds are simple investment products and best for long term wealth creation yet we find that investors track stock market movement and take hasty decisions about their Mutual Fund investments. People invest in  ELSS investments at the end of the financial year, and most of the investments are made at the peak of the market and generally the redemptions are done when markets are not doing good, Sticking to schemes not doing good in anticipation that it will do good in future, is another common mistake. Investors tend to follow herd mentality and thus make investments based on so called hot tips. These are some of the common investing mistakes, lets us now see what these common mistakes are and what one should do or do not.

SIPs are for long term and to achieve specific financial goals don’t stop when markets are uncertain

Systematic Investment Plan route is the best way for long term wealth fact and can be seen by all past data/records. But are we really able to create wealth through SIPs , past data shows that large number of SIPs get closed when markets fall. It is a fact that the investors think long term when they start SIPs but get unnerved with little fluctuation and start thinking short term and stop it as they feel that the market will go down further. In fact, volatility is good for their long term investments as they benefit from rupee cost averaging. We accumulate more units when the markets are down and less when it is up. SIP is nothing but a disciplined way of investing in equities for long term wealth creation. Therefore, tag our existing SIPs with future financial goals, like – Retirement planning, higher education of kids or a world tour and track them. Once we tag our SIPs with specific financial goals we will not redeem them, just keep investing and enjoy the investing journey till such time we achieve your goals.

Equity mutual funds are for long term don’t sell it in emergency

Many people redeem their equity mutual funds when they need funds which is not correct. Mutual Funds especially Equity based mutual funds are for long term, and therefore, should not be redeemed before we get the desired returns or your goal is achieved. So, how to get money in case of an emergency situation? For emergency purpose we should keep money in liquid or short term funds. The way we build long term wealth by investing in equity mutual funds, similarly by investing in liquid or short term debt funds we can build the emergency corpus. In fact, while starting a SIP in equity mutual fund, we should also start a SIP in a liquid fund or short term debt fund. Returns from liquid funds vary between 7-8% and can be redeemed without exit load in T+1 day. Therefore we will get the funds one next working day of redemption and can use it for emergency. There are some funds who provide debit/ATM card also by which (upto certain limit) funds can be withdrawn immediately also.

Market is over smart don’t try to time it

Some time we tend to hold the investments waiting for an opportune time to start with. This opportune time is nothing but the levels of the market. For an Investor the Sensex level of 21,000 may not be the right level to start as he feels that the market may go down further while another investor feels that 28,000 levels is a good time to start as he feels that markets will go far off in the future.

So, how to avoid this? Well It is difficult to answer as this has less to do with investing and more related to our own behavior. When it comes to investing, that too equity investing, investors are not as rational as they think they are. Majority of the Investors get optimistic when the markets are on upward move or doing well and assume that it will continue to do so. On the other hand, many investors become extremely pessimistic during volatile periods. We tend to place too much importance on current market events while ignoring past performance of equity as an asset class. Also, investors show a different degree of emotion towards profits or gains than towards the investment losses. They are emotionally more stressed by prospective or booked losses than they are happy from profit or gains.

The question is how to handle these emotions? In reality it is impossible to time the stock market and thus there is no sure shot way to “buy low and sell high”. The best way to ride the volatility is to invest in a discipline manner by investing regularly i.e. SIP. The other way to arrest the volatility is to invest according to your asset allocation, based on your needs, risk taking ability and by linking the investments with your future goal.

For example –

If your risk profile indicates that 50% of your investment should be in equities than you must consider an investment horizon of 5-7 years to reach to that level. You should invest your monthly surplus through SIPs and link this to one of your long term goals. In case you also have lumpsum amount in your hand then you may put it in a liquid fund and do a weekly/monthly STP to an equity fund for the long term. We can also keep certain amount in balanced funds which are normally more inclined to equity funds. This will ensure that you are not investing all your money in one go and ensuring maximum averaging by investing weekly. On the other hand you earn superior returns than your savings bank account by investing in liquid funds.

For the rest 50% investment (which you can not keep in equities due to your risk profile) you may keep a part say 25% of it in liquid and short term funds to meet any emergency fund requirement. Another part can be kept in long term/dynamic debt funds with a view of 1-3 years or Capital protection funds. In case markets remain choppy and do not generate any positive return during these three years, you will still have positive returns from your debt, liquid and capital protection funds. Needless to mention, your equity investment will continue to acquire more units at lower prices during this period and shall earn much superior returns when the markets start doing good.

The above simple solutions, if followed, will ensure that you spend more time in the market than timing the market.

Do not hold over- diversify by too many Mutual Fund schemes

I know one person who selected 10 schemes for doing a monthly SIP of र 15,000. He has chosen one equity fund each from different equity categories and selected the top performing fund from the respective category based on 5 years return. What the investor failed to understand is that each category has a different objective which may or may not match with his risk profile. Moreover, over diversification does not mean more return or less risk. In fact, it can be more risky and possibly generate lesser returns.

Investing in too many schemes is most of the time overlapping of investments in the same kind of portfolio or companies. Investing in same stocks through different schemes is meaningless. Moreover, if you keep more schemes then tracking their respective performances could be cumbersome and may take more time.

Mutual Fund invests in diversified portfolios of equities and debt etc. Therefore, the investor should choose a fund from a category which is best suited to his risk profile. For example – a young investor can put entire money in equity funds and choose to invest in small and midcap funds. A person with medium risk profile may choose to invest in Balanced Fund and a conservative investor might invest in debt funds only. So once we know your risk profile, we should choose 1 -2 funds from each category and invest. Generally speaking, if we are investing in equity mutual funds and want peace of mind than Diversified Equity Funds are the best investment option. If we can select two or three good diversified equity schemes your investing objective will be fulfilled.

Don't love the scheme but the performance

Investing in Mutual Funds may be simple but selecting a good fund and monitoring the performance of the fund is not easy. To get the maximum return or also to know if our scheme is performing in line with its peer group, it is suggested that we should review our mutual fund portfolio at least once every year. Based on our experience we find that investors hold on to the underperforming schemes with the hope that it will start performing when the markets recover. But most of the time it may not be the case.

First indicator to monitor mutual fund scheme’s performance is that if the scheme is continuously beating the benchmark and also how it is doing in comparison to its peers. We should not get emotional with our investments. Check the performance atleast once every year and replace it with a good scheme if it is not performing well.

To conclude

Unfortunately, in our country, equity investing is hugely influenced by common mistakes and myths. By this post we tried explaining the benefits of investing through SIPs, how asset allocation and setting goal is the most important aspect of equity investing, how one should not get carried away with ones investment and how to overcome some investing behaviors in order to get the desired returns from our investments with much less efforts and no stress.