Ground Rules of Mutual-Fund Investing | Value Research Overwhelmed by the noise about mutual funds? It's your money. Take charge. Resist the noise. Before you ride a fund, here's the ABC of mutual fund investing. Follow the do's and don't before you commit your savings.
Wealth Strategy

Ground Rules of Mutual-Fund Investing

Overwhelmed by the noise about mutual funds? It's your money. Take charge. Resist the noise. Before you ride a fund, here's the ABC of mutual fund investing. Follow the do's and don't before you commit your savings.

Mutual Funds are increasingly being touted as the retail investors' investment vehicle. But to add to your confusion investing in them not as easy with the wide variety available today. To top it 26 new funds were launched in 2000 alone till now. But the good news is that it gives you choice and the benefit of growing competition – service and endeavor to perform. Besides, greater transparency and disclosure is driving greater fund accountability to their shareholders, i.e. you and has also made a relatively safer marketplace.

The key challenge is to choose the right fund. But its simple. It only requires a bit of discipline and little time – hardly a cost for a secure financial future. Following are some rules to help invest better and attain your financial goals.

Know Yourself: The first step towards achieving your goals is that you must know yourself. Try to get an idea of how much risk you can handle. Do a tolerance test for yourself. If your Rs. 10000 investment turning into Rs. 6,000 upsets you--even if it could subsequently bounce back--perhaps an aggressive equity fund is not for you.

Reality Check : What are your goals? If you need to turn Rs 10,000 into Rs 50,000 in two years, a medium term bond fund may not be the right answer. Work on setting realistic expectations for both your goals and your funds.

Know Your Portfolio: Look for areas that are over-represented and for those that are lacking. For example, is your portfolio overly concentrated in the large-cap equities or too much of highly rewarding but wildly volatile infotech stocks. Are you missing investments in small-cap stocks?

Know What You Are Buying: Once you discovered yourself, spend some time for a close understanding of your funds. The stated objective of a fund as given in a prospectus is often incomplete and does not reveal much. Based on the readily available portfolio and fund manager's commentary, you can broadly understand the style and strategy followed by a fund. This will help you meaningfully diversify your portfolio. This will also help you assess potential risks. In general, large-cap value funds are less risky than small-cap growth funds.

Examine Sector Weightings: You must know that funds with large stakes in just one or two sectors will likely be more volatile than the more evenly diversified funds. Looking at a fund's sectoral history will help you gain a good perspective. Does the manager move in and out of sectors frequently and dramatically? If so, the fund might get hurt, if the manager is ever caught on the wrong foot.

Check out Your Fund's Concentration: A portfolio with just 20 or 30 stocks or one that puts most of its assets in just a few stocks will likely be more volatile than a fund that's spread among hundreds of stocks. But there could be rewards of concentration. A concentrated portfolio will also get more bang for its buck if its stocks work out. You may want to add a concentrated fund, one that owns fewer stocks or puts most of its assets in the top 10 or 20 stocks, to your portfolio.

But largely, your core funds should probably be well a diversified and more predictable. Though a small allocation to a sector-oriented fund, a more-flexible fund, or a more-concentrated fund could boost your returns.

Assess Performance Appropriately: Past performance is no indicator of future results. Investors should commit this statutory quote from mutual fund prospectus, advertisements and any other literature to memory. It should be recalled more readily than your bank account number. It should be repeated anytime you consider sending money to any fund with a 100% three-month gain.

Why? Chances are that a few months of boom will be followed by bust, as it has happened this year. All the ICE concentrated funds, which were topping the charts fell flat on their face. There was just no escape when their NAVs started declining like nine pins. What should an investor do? Do not concentrate your mutual fund portfolio or invest in a concentrated fund. And, above all, don't focus on short-term returns. When choosing a fund, look for above-average performance, quarter after quarter, year after year.

Be A Disciplined Investor: After you've chosen some funds, stick with them. Don't be afraid to go against the tide, as often the unpopular groups tend to outperform in subsequent years. In other words, small contrarian bets could be lucrative. And discipline is the key. Rupee-cost averaging, or investing a regular amount of money at regular intervals, tends to add value. With a systematic investment plan, you are likely to beat the fund returns.

Know How Much You Pay: Money saved is money earned. So it's always better to pay less than it is to pay more. Expenses are very important with your larger-cap, lower-risk funds, and less critical with small-cap funds and other higher-risk categories. For example, be wary of high expenses when you are considering bond funds. And you can afford to be lenient with the expense of a small-cap or a sector equity fund.

The nuances of mutual fund investing can be endless. But the strength of the mutual fund idea lies in its simplicity. Don't get bogged by the noise and clutter. You could well be on your way to reach your goals by following these basic guidelines and be a smarter investor.

Other Categories