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The number of unique mutual fund investors is up from 37.9 million (April 2023) to 45.2 million (April 2024), an increase of 19.3 per cent, according to the Association of Mutual Funds in India (Amfi) data. A poor experience early in their investment journey could turn many of these newcomers off equities for a long time, which is why they must enter the market cautiously.
Heightened return expectations
Many investors enter the markets with unrealistic expectations. “They expect that history will repeat itself and they will earn very similar returns over a short period,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Advisor.
Their expectations influence their choice of funds. “Investors pick funds that have given supernormal returns in the recent past,” says Arvind A Rao, founder, Arvind Rao and Associates.
Many are investing only in mid and smallcap funds, without realising that returns tend to be cyclical. “If these funds do not do well in the near future, they might get disillusioned and quit,” says Deepesh Raghaw, a Sebi-registered investment advisor. Many do not have an inkling of their risk profile. “They do not know whether they are conservative, moderate, or aggressive investors and hence are not in a position to select a suitable fund,” says Gopal Kavalireddi, head of research, FYERS.
Another common fallacy is investing without setting a financial goal. Such investors are clueless about their investment horizon.
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In their enthusiasm, many overcommit to equities. “They even invest the money they could need in 6-12 months in equities, and that too in volatile categories like sector funds and mid- and smallcap funds,” says Rao.
During bull markets, all investors are avowed long-term equity investors. “Many novices ask the question: If equities are known to give a return of 12-14 per cent over the long term, why should I invest in debt?” says Raghaw. Amid exuberant market conditions, he says, convincing such investors about the merits of asset allocation often proves difficult.
Decide on an asset allocation
Begin your investment journey with realistic return expectations. “Look at the long-term – 10- or 15-year – returns of a fund category and have similar expectations from it,” says Belapurkar.
Investors must know their financial goals, risk profile and time horizon. “They should decide their asset allocation based on these parameters,” says Belapurkar.
Portfolios must be diversified across equities, debt, and gold. To decide their equity allocation, investors may use the rule of thumb “100 minus age” and then tweak it based on their risk profile. Around 10-15 per cent of the portfolio may be allocated to gold.
The balance may go into debt. Allocation to debt acts as a cushion when equity markets fall. A debt allocation also allows investors to rebalance from debt to equities when the markets are down. Allocation to equities must be for at least five years. “Since investors would be entering currently at elevated valuations, they should have a horizon of seven years or more,” says Rao.
The balance may go into debt. Allocation to debt acts as a cushion when equity markets fall. A debt allocation also allows investors to rebalance from debt to equities when the markets are down. Allocation to equities must be for at least five years. “Since investors would be entering currently at elevated valuations, they should have a horizon of seven years or more,” says Rao.
Exposure to volatile assets useful
Having decided on the asset allocation, investors should then focus on sub-asset allocation: how much to allocate to large, mid and smallcap funds. This decision should again depend on the investor’s risk profile: conservative investors should have a higher allocation to largecap funds, and vice versa.
Younger investors, and those having the required risk appetite, should have some exposure to the more volatile mid- and smallcap segments. “Only if you have experienced a steep market fall followed by a recovery will you become comfortable with volatility,” says Raghaw.
Younger investors, and those having the required risk appetite, should have some exposure to the more volatile mid- and smallcap segments. “Only if you have experienced a steep market fall followed by a recovery will you become comfortable with volatility,” says Raghaw.
Many financial advisers suggest going for low-cost passive funds, at least initially. Besides low cost, investors do not have to worry about selecting the right fund manager (or changing one if she underperforms). Kavalireddi emphasises paying heed to a fund’s risk parameters.
Finally, avoid trying to time the market. “Staying invested for the long term is the way to make money in equities,” says Belapurkar.
