Begin fund foray with consistent performers
Build diversified portfolio; avoid chasing funds with high recent returns
The mutual fund industry added 8.2 million new folios in 2020-21, according to data from the Association of Mutual Funds in India (Amfi). Despite salary cuts and loss of business revenue amid the pandemic, new investors continued to flock to mutual funds. These investors must avoid the common pitfalls that newcomers are prone to.
Get asset allocation right
New investors should consider their investment horizon, age, their stage in the wealth accumulation cycle, and their risk appetite while deciding on their asset allocation. Those who are younger, have a longer investment horizon, fewer financial burdens, and a higher risk appetite can allocate more to equities.
While setting up his retirement portfolio, a 25-year-old, reasonably aggressive investor could allocate 70 per cent to equities, 20 per cent to debt, and 10 per cent to gold. A more conservative investor, or an older one, could go for a 50:40:10 allocation.
Next, decide on the subasset allocation. On the equity side, have, say, an 80 per cent allocation to domestic equities and 20 per cent to international equities. The domestic equity allocation could be split as follows: 70 per cent to large-caps, 20 per cent to mid-caps and 10 per cent to small-caps (risk-averse investors may avoid small-cap funds). More conservative investors may have a higher allocation to large-cap funds, and vice versa.
These are broad guidelines. Investors should tweak these numbers to suit their specific situations. “In rising markets, don’t move more money into equities as this will expose you to risks you may not be equipped handle,” says Saumya Shah, founder, Tarrakki. Similarly, when markets fall, don’t allow yourself to go underweight on equities. Investors must rebalance their portfolios every six months.
Equity funds: Look for steady performers
First, think about a fund for your large-cap allocation. “It is becoming increasingly clear that active funds will find it difficult to beat an index, such as the Nifty 50, over the long term, so go with a low-cost Nifty 50 index fund,” says Deepesh Raghaw, founder, Personalfinanceplan, a Securities and Exchange Board of India-registered investment advisor.
For your mid- and smallcap allocation, use activelymanaged funds. If you wish to go passive even in this space, go with a fund that picks stocks selectively from a broad index, based on, say, high liquidity.
Besides market cap, diversify by style. As your portfolio grows, include a value fund in it.
When selecting an active fund, look for a consistent performer. “Go with a fund that has beaten its category average consistently over the past five or seven calendar years,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisers. For your international allocation, use an S&P 500 based index fund.
Stick to low-risk debt funds
Investors would already be contributing to Employee’s Provident Fund, Voluntary Provident Fund and Public Provident Fund. “Initially, manage your long-term debt allocation with safe, government-backed instruments. Once you enter the 30 per cent tax bracket and need more favourable tax treatment, turn to debt funds,” says Raghaw.
The bulk of your debt fund allocation should be to shorter-duration funds. “About 80-90 per cent of your core debt allocation should be in short-duration funds and corporate bond funds, which carry very little duration or credit risk. Only 10-20 per cent should be in riskier funds like dynamic bond funds or credit risk funds,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India. For investors who wish to be more conservative, Raghaw suggests a money-market fund for their core allocation. “If you have a defined investment horizon, you may use a target maturity debt fund,” says Dhawan.
For your gold allocation, use sovereign gold bonds if you won’t need the money for eight years. If you could need it earlier, use gold exchangetraded funds.
Finally, the most common mistake new investors make is to select categories and funds based on high past returns. In equity funds, the best performers are usually sector or thematic funds, which are very high-risk and should be avoided. Investing only in mid- or small-cap funds can also hurt. In debt funds, yield to maturity, and not past returns, is a better indicator of future performance.