11/11/2011 4:04 PM Friday
Equities play an important role in the portfolio of a long-term investor. While it is a well-known fact that equity investments require time commitment, a disciplined approach to investing too is important to ensure success. For most investors, however, the dilemma is whether to invest directly in stocks or to invest through mutual funds.
It is true that if one has the ability to make the right stock selection and analyse the impact of various events, both national and international, on the economic environment, as well as the profitability of the companies in the portfolio, returns can be better as compared to a diversified vehicle like an equity fund. However, for individuals who are not familiar, all of this can be quite overwhelming. At the same time, if the stock selection is not good, one may be exposed to a much higher risk.
Besides, many investors investing in the stock market either end up having very few stocks in their portfolio or having an over-diversified portfolio. While a portfolio that has very few stocks exposes an investor to the risks associated with a concentrated portfolio, over-diversification in a portfolio can result in poor quality stocks that negate the performance of better-performing stocks.
This is where a professional mutual fund manager, who has access to research, can make a difference by making rational decisions about which stock to include in the portfolio and which to sell.
Besides, investing in a mutual fund rather than directly in stocks has other advantages too. 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, enabling investors with different risk profiles to choose the appropriate ones to achieve their investment objectives. There are plenty of options even for aggressive and knowledgeable investors. 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 only a particular stock.
In a nutshell, mutual funds can be a better option for common investors, as they allow them to balance risk and reward while designing their portfolios. However, to be a successful mutual fund investor, one has to follow the right process for scheme selection. Many investors err on this aspect of mutual fund investing.
Though selecting the scheme should ideally be the last step in the process of decision making, most investors make this the first step. As a result, they end up investing in funds that may not suit their objectives. Therefore, the first thing an aspiring MF investor needs to do is to establish what type of portfolio he/she wants to have. The offer document of a mutual fund scheme clearly states its objective/s and the likely asset mix.
Performance can be a useful tool for judging which scheme to get into. However, it is important to keep the performance in perspective. The objective should be to select a fund that is managed well and provides consistent returns. For a long-term investor, it is equally important to have the right mix of equity funds. For example, if one were to go by only considering short-term performance and select the top three-four funds, chances are that one may end up investing only in a particular class of equity funds.
For those who find the process cumbersome, taking help from a professional advisor can make things simpler and more effective.
By Hemant Rustagi - CEO, Wiseinvest Advisors
Find More Articles on: DSIJ Magazine, In Focus, Personal Finance, Mutual Funds