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How To Become A Better MF Investor In 2013

| 12/27/2012 9:00 PM Thursday

This new year, it’s time to let go of flaws in your MF investment strategy. Hemant Rustagi advises you on the key factors that should guide your investment process.

KEY POINTS:

  • The key to investment success is to build a portfolio that maintains the right balance between risk and reward.
  • Asset allocation determines how you divide your portfolio among different investments and thus helps in controlling risk, as different asset classes react differently to changes in market conditions. A majority of the portfolio returns come from asset allocation and not from the investment options themselves.
  • The market cap of a company has a role to play in the kind of returns a stock may deliver and the riskiness or volatility that you may have to encounter from the stock. Large-cap companies are usually more stable during turbulent periods, while mid-cap and small-cap companies are more vulnerable.

With the new year just around the corner, it may be time to review your mutual fund investments. Remember, despite being one of the most dynamic and simple investment options, MFs require investors to follow the right strategies and philosophies. If you haven’t been following the right process to invest in them, you need to know what to do in 2013.

Define Your Risk Profile

Risk tolerance plays a significant role in designing an optimum investment strategy. In fact, the key to investment success is to build a portfolio that maintains the right balance between risk and reward. Hence, you must follow the right process to determine your risk profile. Here are a few guidelines:

  • You need to determine your ‘comfort level’ with regard to volatility. Simply put, you must seriously consider the effect of potential downsides as well as upsides.
  • Within a defined level of risk tolerance, you must adhere to the principles of effective diversification. This will help you in achieving a variety of distinct risk/reward objectives and reducing the overall portfolio risk.
  • Reassess your risk tolerance at least on an annual basis. Remember, sometimes the risk tolerance may change either due to major adjustments in your return objectives or on account of a realisation that the existing risk tolerance is inappropriate for your current situation.

Follow A Proper Asset Allocation Strategy

Asset allocation is a method that determines how you divide your portfolio among different investments. In other words, it helps in controlling risk as different asset classes react differently to changes in market conditions such as inflation, rising or falling interest rates or a market segment coming into or falling out of favour. Overall, asset allocation determines the kind of risk you would be taking and the commensurate returns you can expect from your portfolio. It is a proven fact that a majority of the portfolio returns come from asset allocation and not from the investment options themselves.

Asset allocation is different from simple diversification. For example, if your portfolio has five equity funds either with similar investment strategies/philosophies or that invest in stocks belonging to same market cap, it won’t do much to control the risk in your portfolio. In case of an adverse reaction, all these funds will react in a similar way. On the other hand, different asset classes will react differently in any given situation.

Mutual funds are the most appropriate vehicle to practice asset allocation successfully. They not only provide diversification but also offer a ‘family of funds’ to suit the objectives of investors in different age groups with varied time horizons and occupations. Moreover, they also provide opportunities to re-balance your portfolio, which may be required due to changes in your circumstances.

Have Appropriate Exposure To Different Market Caps

The market cap of a company signifies its market value, which is equal to the total number of shares outstanding multiplied by the current stock price. This has a role to play in the kind of returns a stock may deliver and the riskiness or volatility that you may have to encounter from the stock. For example, large-cap companies are usually more stable during turbulent periods, while mid-cap and small-cap companies are more vulnerable.

As regards the allocation to each segment, there cannot be a standard combination applicable to all kinds of investors as each of us has different risk profiles, time horizons and investment objectives. Therefore, the allocation to these segments would depend upon the fact whether you are an existing investor or a first-time investor. While for an existing investor, the existing allocation needs to be considered, for a new investor, the right way to begin is consider well-diversified funds that invest predominantly in large-cap stock and have a small presence in mid-cap and small-cap stocks.

It is always advisable to take help of professionals to decide the allocation as well as to rebalance the portfolio from time to time. However, as an investor, you have an important role to play in this process, as your outputs define the broad parameters to get the allocation right.

Hemant Rustagi
CEO, Wiseinvest Advisors

 

Find More Articles on: DSIJ Magazine, In Focus, Personal Finance, Mutual Funds

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