The real do-it-yourself challenge

How do you decide which fund to invest in? In fund investing, it's probably the most asked question. This is what investors ask from fund salespeople and advisors and I dare say, this is what investors ask themselves. But it's the wrong question. The real question is, what type of fund should you invest in. That's the difficult part and once that's decided, deciding the actual fund is simple enough. Well, at least it's much simpler.

Here's the reasoning: when you think about the inputs that go into deciding which fund to invest in, the primary inputs that you have are your financial needs. Obviously, those actually map to a fund category. Then, once that is decided, the next step is the task of choosing which fund in the category is a good one. Like I said, if you have chosen the right category, that's not difficult.

For example, if you need to save money for something that will be needed after 10-15 years and want more returns than deposit-type options can offer, then the obvious choice is an equity category. Within equity, depending on a few other criteria, it would be suitable to have some combination of equity funds that are large and mid-small cap. If you are a new investor starting with a small investment size, all your needs could be met by just one or two hybrid funds. There are various principles and thumb rules that map from the financial requirement to the fund type.

However, a plain description of the process makes one feel that the only input that goes into choosing a fund type is financial. The truth is far from that. When you actually interact with a lot of investors, you realise that there is another hidden input that is much more difficult to pin down and that's the psychology of the investor. Look at the small and simple financial input above. 10-15 years, high returns needed. One would say that regardless of the investor's own profile, equity is the way to go. So, compare two different types of investors who both have the above financial requirement. These are both actual cases whom I personally advised recently. One is around 40 years old, working in a tech job and has been investing in mutual funds for more than a decade. The other is about to retire from a fairly senior government job and has routine expenses taken care of by the pension, healthcare and also has a house.

Very clearly, the older person is quite risk-proof, much more so than the younger ones. Since the money will be needed only after 15 years or so in both cases, an aggressive equity plan is called for and here's the thing: if you take only financial considerations into account, the older person should go for a more aggressive investing plan. However, you can well imagine how that idea collides with the psychology of the individual. A lifetime of indoctrination about the investment paths that should be taken by young people vs older people vs retired is not easily changed. The strange thing is that not only is the older person unwilling to consider a volatility level that is appropriate, despite understanding the theory of why that should be done.

What is the solution to this kind of thing? Unfortunately, it's not just words, whether they come from an advisor or an independent analyst or some such thing as a 'financial literacy' tutorial. It's only time and experience. Someone has to sit and gently get this person to invest some amount - small enough - in fund categories where the point gets proven in three or four years. That's a kind of an educational/experiential portfolio, where you experience the thing yourself and then get converted. Needless to say, no one who works commercially to get you to invest has the time, the knowledge, the patience and the commitment to do this for you. The solution is reading online and offline resources and self-education. It's unfortunate that there's no ready-made method, but that can't be helped.