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Old investor, new deal

The best solution for beginners (and also many experienced ones) is to avoid pure equity funds and stick to equity-debt hybrid funds. Here's why


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Of my friends and acquaintances who regularly take investment advice from me, one of the most interesting is an Indian Air Force officer who retired before I was born. In many ways, his half a century (literally) of retired life is an object lesson in the value of doing simple things in investing and doing them for a long time. Of course, my friend is a prosperous man without any financial worries--his pension being about 350 times than the last salary he drew in 1966! While he does invest in some funds and stocks, like many (most?) people of his age and background, his heart is most at peace with fixed deposits in public sector banks.

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Even so, he has some fascinating equity investments in his portfolio. One is that of a multinational company, long listed in India, in which he bought a 100 shares at the time of his retirement. The price of the stock in 1966 is now long forgotten, but in this half a century, the number of shares has increased from 100 to about 14,000 through bonuses and splits. The value of this investment has gone up from whatever few rupees it had been at the time of purchase to a sum that is well into eight figures now.

One would think that my friend would be quite sanguine about volatility in a stock where he has made so much money, but no, that's not the way things are. Even now, after 52 years of gains, whenever that stock falls, he gets worried about it. Over the last few months, as the equity markets have turned shaky, the stock has lost around a quarter of its value, and my friend is fretting, just as he does in every market downturn. He feels that he should finally sell out, even though I know that he actually will not. Whether his worries are justified or not (and they're not), such stress is common. There are just a few investors who do not have it at some point. However, by and large, seasoned equity investors, those who invest regularly in stocks, get used to them sooner rather than later.

The greater problem is that of mutual fund investors. To reap the benefits of equity returns, they must stay invested. And yet, when the markets are weak, the daily fluctuation in the NAVs of equity funds are enough to make many of them sell and run. Those with more fortitude eventually make enough money, but many cut and run, which is a pity.

That actually brings us back to what I discussed last week. Once you appreciate the logic of asset rebalancing, then even if you're the sort who has the mettle to tolerate volatility, you will probably prefer a hybrid fund. I've always thought that the best solution for beginners (and also many experienced ones) is to avoid pure equity funds and stick to equity-debt hybrid funds. They have equity and fixed income in a certain ratio which the fund manager maintains. The regular rebalancing saves your equity gains when the markets turn turtle.

However, just like SIPs, the real advantage of hybrid funds lies not in the maths but in the psychology. I've been seeing for years that in circumstances when many investors in equity funds cut and run, hybrid fund investors stay put. The losses are simply not enough to scare them. Amusingly, I've often observed that this fastness of purpose is actually enhanced by the sight of equity funds' greater losses. Basically, hybrid fund investors enjoy telling themselves that they are smarter than equity fund investors.

Moreover, SEBI's recent overhaul and formalisation of fund categories has delivered what is effectively a new deal for mutual fund investors, and specially hybrid fund investors. In one of the coming weeks, we'll walk through why this is the case and the exact advantage that each of the new hybrid categories can deliver to you.

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