New investors: Shun yesterday's winners, diversify across sectors

Those taking MF route may begin with a passive fund, gradually invest in various market caps, asset classes

The Indian stock market soared to fresh peaks this week. Reports reveal a mixed trend of some existing investors booking profits and retreating from direct equities, and new investors being drawn to it (as is evident from new demat account openings touching a nine-month high in May). At the same time, equity mutual fund (MF) inflows have skewed towards mid- and small-cap funds.

“Any asset that has surged rapidly tends to grab the headlines, spurring people to invest. Frequently, they do this without grasping the nuances of that asset class. When it undergoes a correction subsequently, these investors experience disappointment and heartache,” says Mayank Bhatnagar, chief operating officer, FinEdge. New investors should make a cautious entry into the equity market.

Start of a fresh bull run?

The new highs in the indices are coming after a period of correction (October 2022 to April 2023). Present valuations, while not inexpensive, are not overly inflated. If the Bloomberg consensus earnings growth estimates of 14.5 per cent for FY24 (202324 financial year) and 16.2 per cent for FY25 materialise, the market could rise further.

“The recent surge in the equity market may herald a new bull market cycle,” says S Sridharan, founder and chief executive officer (CEO), Wallet Wealth.

Concerns remain

Inflation continues to be a worldwide concern. The Reserve Bank of India (RBI) and the United States (US) Federal Reserve have both paused rate hikes. However, the dot plot, a representation of the US Federal Open Market Committee (FOMC) members’ expectations, indicates two more rate hikes this year. The threat of the US and several European economies succumbing to recession persists, and the Ukraine-Russia conflict continues.

Long term horizon a must

Novice investors should consider equities only if they are prepared to stay put for the long haul. “The market will exhibit volatility in the short run. Avoid equities if your investment horizon is shorter than three years,” says Sridharan.

If you opt for individual stock investments, resist getting overly concentrated in any stock or sector.

New entrants should also avoid investing in the winners of the previous rally as each bull market ushers in new leaders. “Don’t invest with an eye on the rear-view mirror. Future upside, which depends on corporate profitability over the long run, is what counts,” says Bhatnagar.

Investors not equipped to conduct extensive research on individual stocks should consider the MF route.

Avoid selection risk

For novice MF investors, picking the appropriate active fund can be challenging. Their investment journey should start with a simple Nifty50 index fund or exchange-traded fund. They should stick to it for a year or two until they become accustomed to market volatility.

If they favour active funds and can access professional advice, they should construct a diversified portfolio consisting of large-cap mid-cap, and small-cap funds. To build a diversified portfolio with a single fund, they may use a flexi-cap or a multi-cap fund.

Counter mid-cap, small-cap bias

In the past year, large-cap funds’ returns (19.7 per cent) have trailed behind mid-cap (31.5 per cent) and small-cap funds (28.61 per cent). Nevertheless, large-cap funds play the crucial role of mitigating portfolio volatility. “Maintain a balance between large-cap funds on one side and mid-cap/small-cap funds on the other,” says Anil Rego, founder, and CEO, Right Horizons.

Diversify across asset classes

When equity markets are buoyant, investors often rush to pour money into this asset class. This impulse should be resisted. “Make the correct allocation to equity, debt, and gold based on age and risk profile,” says Vivek Bajaj, co-founder of StockEdge.

Sridharan adds that gold provides robust returns amid economic uncertainty, while debt offers stability during bearish periods. According to him, investors with a high risk appetite and a seven-plus-year horizon could opt for a 70 per cent allocation to equities, 20 per cent to debt, and 10 per cent to gold. Moderate or conservative investors may consider multi-asset allocation funds.

Finally, Bajaj suggests that since it’s difficult to time the market, investors should invest via systematic investment plans and systematic transfer plans without concerning themselves with market peaks and troughs.