Mutual funds are investment instruments that can be truly appreciated when you look at it from a long-term perspective. If you look at anything on a daily or monthly basis, it is bound to be volatile. Volatility is an inherent part of equity markets, which is why the pay-off (in terms of returns) is huge. But, as your lens turns to a 5-year or above perspective, the volatility seems a bit less sharp and losses tend to be capped. Here is a check list of things you can do to exploit the slump in your favor:
- Continue your SIP: Investors know enough to expect volatility in equity markets. Though most of them are wary of it, but when the market is down, investors tend to lose hope and discontinue their SIP abruptly. The risks of greater market volatility drive them to stop their investments. However, this is the wrong approach as far as SIPs are concerned. Continue your SIPs! You can buy more mutual fund units for the same price when the market is down. In the long run, this can help bring down your total cost of investment. Additionally, SIP investments are distributed over several months. This also helps reduce the adverse effects of market downturns.
- Goal-linked investments: It is very important to link your mutual fund investments to financial goals you plan to achieve. For example, wealth creation is a financial goal. Once you are clear about what your goal is, you should begin your investments. We all know that our current and potential future income will not be enough to fulfil all our goals. Therefore, an accumulation of investments over a long period of time, preferably through SIP route powered with compounding, could generate the desired results.
- Think long term: It is always beneficial to invest in equity mutual funds for the long term. The longer tenure will help you tap into averaging benefits of SIP. That is when you stand a chance to get reasonable returns. Historical performance over various periods of time suggest that your investments are less likely to be loss making if you hold on for long period, say over 10 years. Moreover, by increasing the tenure of the SIP, you can also lower your monthly SIP installments.
- Take advantage of index funds: When the markets fall, it is the right time to make a lumpsum investment into a good index fund. Its performance tends to mirror that of the index it is replicating. Index funds are passively managed funds that allow investors to participate intelligently in the stock market. Since the index fund is passively managed, the expense ratio is very low as compared to actively managed funds. Index funds don't always beat actively managed funds but their low costs and lower relative market risk make them a smart choice for stable long term performance. Moreover, investing in them during a downturn helps you compound returns swiftly.
- View the downturn as an opportunity: Most investors reduce their exposure to equity mutual funds when stock markets fall rapidly. However, you should be doing the opposite. If you have an investment horizon of 10-15 years, increasing your exposure to equity mutual funds makes much more sense, especially during a downturn. You can either start a SIP, add to your previously held SIPs or invest lumpsum, if you have funds available. Whichever method of investing you choose, make sure you do not lose this opportunity.
Having said that, a bear market is the time when quality perseveres, and you can quite easily separate wheat from the chaff. Given below are the few instances where it is better to discontinue your SIPs and/or shift into a better performing fund.
- The mutual fund you are investing in steadily underperforms the benchmark index: In a bull market, everything works and nearly all mutual funds give substantial returns. However, many mutual funds will start showing cracks in the bear market. If your fund has been consistently underperforming the benchmark, it is time to switch funds. For example, if you have invested in a midcap fund, and it has been continually underperforming the Nifty midcap index for a few quarters, you would do better if you switch to another fund within the same category.
- Change in the investment objective of the fund: Due to various reasons, mutual fund schemes in many circumstances alter or change the investment objective of the fund. Since mutual fund investments are generally linked to your financial goal, investors must assess if the new fund objectives align with their financial goal. If it does not, it is better to shift your investments to a fund that is in tandem with your goals.
- Your financial goal timeline is nearing: If the deadline to the financial goal you are allocating funds to is 1-2 years away, it is better to shift your funds from equity mutual funds to debt. In the short term, debt is less volatile than equity. Further, as you approach the end of your goal, it is better to focus on capital preservation rather than high returns.
- Change in fund manager: A change in the fund manager or the management team as a whole should be watched carefully by investors. This does not mean that investors should switch funds if there is a change in management. Investors just need to take note and be a bit more cautious. A periodic review of the fund performance after the change should be done. If the performance is negatively affected by the modification, then it is wise to switch funds.