Equity haste makes waste
7/18/2011 5:53 PM Monday
Although equities have failed to find a regular place in the investment universe of retail investors, their importance in the wealth-building process cannot be undermined.
It is important for investors to understand that an asset class like equity requires time commitment and hence one must have the patience to wait out the turbulent times. If you are one of those investors who are in the process of understanding equity investing, the most important factor is to ascertain whether you have chosen the right method of investing.
It is true that if you have the capability to select the right stocks as well as analyse the impact of various events on the companies in the portfolio, investing directly in the stock market can give better returns as compared to a diversified vehicle like an equity fund. However, if the stock selection is not good, you could expose yourself to much higher risks when the stock market turns weak. Remember, the stock prices move to anticipate events as well as reflect current events. Therefore, considerable research has to be carried out trying to forecast the performance of the economy, industries and the companies. For someone who is not familiar with the process, it can be quite overwhelming to do so.
Therefore, to begin with, it makes sense to entrust the job of managing your money to a professional fund manager who not only has access to research but also has the capability of making rational decisions. Besides, investing in a mutual fund rather than directly in stocks has many other advantages. Apart from being an easy method of investing, it is much easier to track performance as one has to track only one price i.e. the NAV instead of several stock prices. Mutual funds offer a wide variety of equity funds ranging from diversified to specialty funds, thus enabling investors with different risk profiles to choose the right ones and achieve their investment objectives.
Even for aggressive and knowledgeable investors, there are plenty of options. For example, a sector fund can not only be a perfect substitute for buying a few stocks from a sector that one likes but also takes some of the risk out of owning a particular stock. As is evident, it makes sense to entrust your money to professional fund managers. It is equally important to understand the nuances of equity investing. For example, you must know how to deal with the volatility associated with the markets. While all of us would want our portfolio to do well at all times, in reality there can be certain time periods when the performance of some of the funds may slip or become inconsistent. While uncertain times can create panic, it is necessary to analyse the reasons for the fall in the NAVs.
If the fund loses ground in a falling market and falls in line with its benchmark index, it should not be much cause for concern. However, if the fund goes down when its peers are going up, it should be taken as a warning signal. There are a few other aspects that an equity investor must know. First, it is important to understand that different segments of the market perform differently at different times. As the tide shifts in favour of a particular segment, the performance of funds focusing on that segment improves dramatically. Second, one must hold a fund long enough to evaluate its performance i.e. at least a year or so. Many of us make the mistake of either holding on to funds for too long or making an exit in a hurry.
In other words, if one takes a wrong decision there is always a risk of missing out on good rallies in the market or getting out too early, thus missing out on potential gains. In a nutshell, mutual funds can be a better way of investing in equities as they allow you to balance risk and reward while designing your portfolios. Therefore, you must make MFs an integral part of your portfolio to get the best out of this wonderful asset class.
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