Principles To Follow While Investing In Equity MFs

In investments, getting more rights than wrong while making investment decision, is what that makes you a better and successful investor. You can increase your chances of making right investment decision if you follow the following simple principle of investing in equity mutual funds.



Diversification: It simply means investing in different asset classes in order to ward off impact of poor returns from any one asset class on the overall portfolio. Historically, it has been witnessed that prices of different asset classes does not move in tandem. Even within the asset class, the performances of sub-asset class vary every year. For example, while Indian equity market in general has not been doing well since 2018, large cap equity mutual funds have been giving positive returns while mid cap and small cap funds have been bleeding.



In the above graph, we have considered annual returns of three different funds category based on market capitalisation. You can see that different funds category swing widely in their performance in different years. For example, mid cap fund was the worst performer in year 2011, however, it was the best performer in the following year. Hence, while investing even only in equity mutual fund schemes, it is always recommended to diversify your investments in three-four funds from different categories.

Asset Allocation: It involves investing in various asset classes or sub-asset classes within an asset class depending upon your risk profile and financial goal. If you are considering investing in mutual funds, you should allocate some part of your investment into debt funds depending upon your age and risk profile. Asset allocation is considered to be the cornerstone of portfolio returns and helps to improve the overall performance of your portfolio.



The above graph shows performance of two funds: equity and debt. Returns of the debt funds has been low but consistent compared to equity funds. In last two years, debt funds have outperformed equity funds.

Allocating your asset will help to improve the overall investment experience, if not the returns in long run.



Do not follow wing-it strategy: This is one of the most commonly followed strategies especially among newbies. If you are not following a specific plan or structure in making your investments decision and building your portfolio, you are likely employing a wing-it strategy. Investing without any plan is similar to starting a journey without any destination. So, you might end your journey somewhere, however, that may not be the place you wanted to be. 

Core and satellite investment is based on the concept of asset allocation, which means investing in a broad variety of asset classes in order to meet your overall investment objectives. As the term suggests, core investments mean having a core of long-term investments while satellite investments means having more specialist or shorter-term investments. 

Without a plan for investing, you might struggle to make decisions that accurately reflect your investing goals. Most experts agree that this strategy tends to be least successful because of its lack of consistency. On the contrary, if you are investing with a strategy in the mind, it will guide you in making right investment decision and achieve your financial goals.

Check the expense ratio:

In 2010, one of the most renowned investment research company, Morningstar, released the results of a study on the best way to predict future mutual fund returns. They acknowledged that they could not beat the ‘cost’ as a predictor of future returns even with all the expertise and precision. Least expensive mutual funds outperformed the most expensive mutual funds in every single case and across every single type of investment.

Generally it is believed that costly is always good. However, the opposite is true in case of mutual fund investments. Every rupee that you pay in terms of fees is the amount that is not being invested and hence fails to take the advantage of exponentially compounding returns.The less you have to pay, the more likely you are to get the results you want. 

Although, the difference in the expense ratio looks miniscule, it makes lot of difference in long run. 

In the graph above we see the movement of performance by“direct” and “regular” funds of Invesco Multicap fund. It is clearly visible that direct plans have generated better returns than regular funds. In terms of returns, difference between both types of funds in last six years has been 11 per cent. Returns data comparision is available only from January 2013.

Differentiate between core and satellite investments:

Various academic researchers have consistently proved that asset allocation determines the greatest part of a portfolio’s investment outcome over the long term. Core and satellite investment is based on the concept of asset allocation, which means investing in a broad variety of asset classes in order to meet your overall investment objectives. As the term suggests, core investments mean having a core of long-term investments while satellite investments means having more specialist or shorter-term investments.

There are various ways in which you can build core-satellite portfolio. One of the ways is to use index funds as the ‘core’ of your portfolio, which will provide you with an effective, diversified, lower-cost foundation for an investment portfolio, while the satellite funds should be selected based on the opportunity in the market and your financial goals.

The exact amount that should go to your core and satellite funds will depend upon the individual investor. 

Funds with least downside risk should be preferred: Various studies have shown that stocks or funds with lower beta performed better than the stocks or funds with higher beta over a longer period. Lower beta funds tend to fall lesser than their benchmarks. Hence, they also perform better because they have to rise less to recover losses. For example, if a fund’s NAV has fallen by 25%, it has to rise by 33% to recover its losses.

Even our study on returns of all equity funds in last five years prove the same point.



Keep emotions under control : As legendary investor, Warren Buffett, said “if you cannot control your emotions, you cannot control your money”. Emotions plays a prominent role while investing in equity because of their volatile nature. Greed and fear are the most important emotions while making investment decision. Goal based investment helps to keep emotions at bay and make the temptation to time the market unnecessary.

Though investment in equity and equity funds starts with science, it becomes an art with practice and experience. If you follow the above principles, it will help you in better investing experience.