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How can I differentiate between a 'bad' and a 'good' investment?

Dhirendra Kumar gives insight into how to differentiate between a good and bad investment

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How can one differentiate between a bad or a good investment?
- Abbai Bhushan

To explain this, several sessions of Investors' Hangout are required. But, one should take care of two aspects before deciding what type of investment is good or bad. These two aspects include your experience in the market and the appropriateness of your investment vehicle for your goal and investment horizon.

I think the primary reason why investors are disappointed with their investments is when they end up choosing an inappropriate or unsuited investment. If you select a great equity fund but your need for income is for a different purpose, say, you need your money to grow well for just two-and-a-half years, then this great equity fund is not suitable for you. The inappropriateness of this investment will disappoint you. Likewise, if you need a good growth investment and if you have put your money in a great fixed-income fund, it will disappoint you because you won't be able to grow your money into something meaningful.

I come across situations where most people are disappointed with their investments simply because they are inappropriate. India with its risk aversion and inability to reconcile with the equity markets' vileness has a major rule role to play in all this. That is why the public provident fund (PPF) investment is two times bigger than all equity and hybrid funds put together. So, we are largely a fixed income country which is averse to any kind of volatility and thus we miss out on huge opportunities. While PPF has its own advantages, it may not be an appropriate, great long-term accumulation vehicle.

In my opinion, a good equity fund is the one that has done well over a full market cycle - spanning across five-six years. The difference between a good and a bad equity fund is that a good fund actually does little better than the market in a rising market and falls a little less in a falling market. Over a full market cycle, it ends up delivering more returns and beats the benchmark by a modest margin, while the fund manager doesn't jump ships. So, that's a good investment.

Likewise for a fixed-income fund, a good investment will be demonstrated in a full market cycle. In the case of a fixed-income fund, the cyclical cycle is longer as Mr Risk visits you every few years and until then, the fund assuming the greatest risk may not be visible. But when it does, the consequences can be huge. Of late, we have come across many credit situations where fund companies have faced situations where their bond holdings have defaulted. So, in the current scenario, it has become easier to filter between the boys and men in fixed-income funds.