What to do, what to avoid in your first equity mutual fund investment

A conservative approach, diversified portfolio and don't be discouraged by setbacks in the market

Which was your first equity mutual fund? Mine was an equity fund from Fidelity about 17-18 years ago. I picked up the fund after reading the bestselling book ‘One up on Wall Street’ by legendary fund manager Peter Lynch. In the eighties and nineties, Lynch worked as a fund manager with Fidelity. I was so impressed with his writings that I picked up a fund from Fidelity AMC in India. Yes, Fidelity was in India and later sold the business to L&T Mutual Fund (MF). I don’t remember when I exited the fund but it helped me learn a few things about markets.

I will share my thoughts about selecting your initial set of funds. My approach is for relatively conservative young investors who see value in taking a portfolio approach to investments. It is for long-term investors who understand that managing their own behaviour is as important as selecting good investments for their portfolio. I write “conservative investors” but this approach involves risks and you can lose money.

This approach is not relevant for people taking advice from an investment advisor. I believe your advisor would already be structuring a customised portfolio for you in line with your risk profile or financial goals.

It is also not for older investors whose portfolio construction may require greater nuance. While “young” and “old” are subjective, investors older than 35 should give greater thought to their portfolio construction than the simple approach I suggest below.

You can’t invest in the stock markets for 30-40 years on borrowed conviction. You learn by seeing the value of your investments fall sharply, recover, and reach heights. When you have seen that happen once or twice, you grow confident and develop conviction.

Three tips for new investors

Get comfortable with volatility: No matter how inconvenient adverse market phases are, it is important to go through ups and downs. No better way to do this than by investing in an extremely volatile fund. A midcap or a small cap fund comes to my mind. A Nifty Next 50 index fund would also be a good fit here.

Appreciate diversification: You will eventually understand the value diversification adds to the portfolio (the markets will teach you). However, the sooner you diversify, the better. It is easy to get carried away during market booms. During such times, the appreciation of risk goes down and investors turn comfortable taking riskier and riskier bets. Such bets are likely to be in domestic equity funds. To diversify, consider adding a debt fund, or a gold fund/ETF (or sovereign gold bonds), or even a foreign equity fund. You can also consider an asset allocation fund. These funds will provide you different levels of diversification in the portfolio. 

Avoid scars in early investments: Initial setbacks can make you wary and discourage you from equity markets. If you are young, time is your greatest asset. Don’t fritter away this advantage. You don’t want to stay away from the markets because of initial setbacks. For that, you just must ensure that setback is not too big. A relatively stable fund such as a Nifty 50 index fund or a balanced advantage fund will help here. These are equity funds and will be volatile too, but not as much as a mid- or a small-cap funds.

All three points are related. The first point is to help you appreciate the returns potential of equity markets. However, there is no free lunch. High return potential comes at the cost of higher risk. Mid and small caps are extremely volatile. Points two and three are the hedge against the shocks from one.

The second point also helps with the third. By diversifying your portfolio, you reduce the odds of massive setbacks to the portfolio.

Invest through SIPs

Since the intent is to prevent scars, it is better that you invest by way of systematic investment plans (SIPs) and avoid lump-sum investments. Do not try to make too much money too quickly. 

What should be the breakup between funds?

I don’t have an objective answer to this. You can decide the initial percentage based on how much risk you want to take. You can fine tune the percentages later.

Usually, when I am confused, I take an equal weighted approach.

Why make this so complex? Not an unfair question.

You may argue that picking up a Nifty 50 index fund or a balanced advantage fund (as mentioned in point three) is a good way to start. And you do not need one and two. I agree. However, my experience is that many investors want to eventually graduate to have exposure to riskier products (mid and small cap funds) as well. Plus, investors also take time to appreciate the benefits of portfolio diversification. So, when you must add these funds later, why not add them now and not five years later? Let the learning begin now.

There is no “One-size-fits-all solution” when it comes to investments and personal finance. You don’t have to agree or disagree with my thoughts here.

This approach is not so much about earning very good returns. It is more about learning how markets behave and understanding your own behaviour during various market phases. This is only to prepare you for the many years of investing that lies ahead of you. This can be your initial portfolio. Once you grow confident, you can refine your approach and make investments based on your risk preferences and financial goals.

The author is a Sebi-registered investment advisor