Choose The Right Investment Vehicle
3/21/2013 9:00 PM Thursday
Different asset classes require different strategies; this must be recognised by investors for efficient value creation, says Hemant Rustagi.
CEO, Wiseinvest Advisors
Investing money can be quite a challenge in today’s complex financial world. While enhancing financial literacy among investors is important, so is promoting simple and effective investment vehicles like mutual funds. It is a pity that only a miniscule proportion of India’s probable investors are showing an interest in them. The unpleasant experiences of the past coupled with certain misconceptions have resulted in investors staying away from this wonderful investment vehicle.
Considering that investors need to earn a positive real rate of return more than ever before, it’s time for them to change their perceptions towards mutual funds and adopt the right strategies to benefit from their true potential.
It is true that over the years, many mutual fund investors have suffered due to a mismatch between reality and expectations, poor performance of the funds, mis-selling of products and by following the wrong investment strategies. However, the fact remains that investing through mutual funds is a good idea, especially for those investors who may not have the wherewithal to invest directly into the markets (both equity as well as the debt market). The key, of course, is to make the right selection and follow a disciplined approach of investing.
Investors also need to realise that different asset classes require different investment strategies. For example, equity fund investments are for the long term and hence investors must have the patience during turbulent times. Trying to time the markets through equity funds can be a futile exercise. Many investors who try to do so end up making the classic mistake of buying high and selling low. Similarly, by selecting an appropriate category of debt fund, an investor can not only earn higher returns than a traditional investment option but also earn higher post tax returns. Besides, if the objective is to hedge the portfolio, a gold fund or a gold ETF is an apt choice than buying jewellery.
Another important aspect of investing is diversification. Diversification is important because it not only reduces the risk in the portfolio but also allows it to perform in different market conditions. Unfortunately, a number of investors end up making mistakes in diversification. The common belief is that the more the number of funds one invests in, the more diversified the portfolio is. This is a myth that investors have been following for years.
In a portfolio that suffers from over-diversification, the returns get diluted as non-performing funds pull down the overall returns. Moreover, the portfolio becomes quite complicated and it becomes difficult to keep track of a complicated portfolio. Investors need to realise that mutual funds themselves are a diversified investment vehicle. For example, most multi-cap equity funds would have 40-50 stocks in the portfolio and hence the money gets diversified into a number of stocks, industries and segments. Therefore, investors need to look at diversification from the point of view of the portfolio of the funds they are invested in and not from the point of view of their own portfolio.
There are, however, a few steps that can bring back an over-diversified portfolio on track. First, one must identify the non-performing funds in the portfolio. To do so, one must consider the long-term performance track record of the funds. Second, if the portfolio has a number of funds investing in the same segment or following a similar investment style, some of them can be reduced by keeping a few without compromising the level of diversification. Third, one needs to reassess the asset allocation and if the portfolio requires rebalancing, the number of funds can be reduced.
While there is nothing like an optimal number of funds for a sufficiently diverse portfolio, the size of the portfolio and the asset allocation can help an investor decide that number. Another important aspect that requires attention is the level of risk one is willing to take for meeting the returns expectations. Risk tolerance should also be addressed from two perspectives: financial risk tolerance and emotional risk tolerance.
By thus choosing an efficient investment vehicle like mutual funds and by following the right investment strategy to invest in them, investors can make a huge positive difference to their financial future.
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