10 Secrets for successful mutual fund investing

There are no straight answers to these questions. However, what we can do is adopt a more systematic and policy-based approach to mutual funds. Here is how.

Sep 21, 2021 10:09 IST India Infoline News Service

Mutual Funds
With Nifty near 18,000 and Sensex approaching 60,000, there are questions plaguing investor minds. Should they exit equity funds? Is it time to shift to debt funds?

Should one stop SIPs for now? There are no straight answers to these questions. However, what we can do is adopt a more systematic and policy-based approach to mutual funds. Here is how.

1. Have a goal and invest towards that goal

This is the first secret when you invest in mutual funds. Your mutual fund holdings must have a context and this context comes from your financial goals. So, start with your goals. Your thought process should be; when will I retire? How much money I require after retirement? How much to save in mutual funds regularly? Run this test for all goals like retirement, children’s education, second home, nest egg etc. That gives you clarity on how much you need to invest in which category of funds. The rest will automatically follow.

2. Prefer SIPs over lump-sum investments

If you are looking at long-term goals, you cannot wait till you accumulate a corpus. You must start early; ideally with systematic investment plans or SIPs. There are more reasons for a SIP. It syncs with your monthly income flows so there is discipline in investing. Secondly, since you allocate a fixed sum each month, rupee cost averaging works in your favour. You either get more value or more units.

3. Don’t expect consistent returns in the short run

Asset classes are neither consistent nor predictable in the short run. Over a 1 year or 2 year period, mutual funds could be volatile. Don’t give up easily. Any mutual fund is best assessed and evaluated over a longer time frame of 7-8 years. Even debt funds cannot be assessed in the short term.

4. Don’t annualize short-term performance

Once upon a time, mutual funds used to advertise annualized returns. If an equity fund earned 8% returns, it does not mean that the fund would earn 96-100% annually. In fact, that is not only unlikely but almost impossible. Fortunately, SEBI banned this practice as it misled customers, but investors still extrapolate a short-term performance and expect it to sustain over the longer term. That is too optimistic and it does not work that way.

5. Select growth plans over dividend plans

Investors are realizing the merits of growth plans over dividend plans. Dividend plans are a misnomer. Mutual funds don’t pay dividends but liquidate part of your holding value. There are two other problems with dividend plans. Firstly, dividend plans go against the basic idea of compounding which is key to long-term wealth creation. Secondly, dividend plans are tax-unfriendly. Dividends are taxed at the peak rate as other income. You can rather opt for growth plans and pay concessional tax on capital gains.

6. Don’t just look at returns but risk and consistency too

Would you prefer Fund-X giving 14% return with 15% standard deviation or Fund-Y giving 16% returns with 45% standard deviation. Standard deviation measures volatility and the risk of the fund. Here, Fund-Y has earned higher returns by taking on higher risk. This can backfire at any point. Consistency is about whether the returns in each of the last 5 years are stable. More consistent the fund, the less you worry about timing of entry and exit.

7. Diversification is essential, but not beyond a point

Irrespective of what Warren Buffett might say about the merits of a concentrated portfolio, you must diversify risk. However, keep diversification within limits. You can hold 10-12 assets not 50 assets for diversification. Beyond a point, diversification does not reduce risk but only substitutes risk.

8. Don’t look at daily NAVs, but read the fact sheet

Daily NAVs don’t really matter in a diversified portfolio of assets. NAVs only distract you. However, don’t forget to read the monthly fact sheet of the fund. Specifically, look at how your holdings performed versus benchmarks. Also examine if the portfolio of your fund is too concentrated or exposed to thematic vulnerabilities.

9. Reshuffle and rebalance when required

These are 2 different things. Often, the funds you hold may consistently underperform, in that case you must reshuffle and shift to another similar fund. Rebalancing is when your equity / debt mix digresses from your core asset allocation. Both are essential to keep your mutual fund holdings in fine fettle.

10. Follow your fund manager on Twitter and Instagram

Is there merit in doing this? You get two insights this way. Firstly, you get to know the perceptions of your fund manager. Secondly, you get an idea about what the public at large are talking about the fund and the manager. These may be trolls, but you are not counting on social media anyways. It is just a supportive data point.

Don’t stress too much about levels of Nifty, Sensex or RBI stance. If you follow basic secrets, you can be a meaningfully successful mutual fund investor.

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