A Simple Investment that really works
We do not know what the future holds. A good investment should be able to bring a smile on your lips for having taken the 'right' course in the face of uncertainty. What is this investment?
Equity mutual funds have proven to be profitable long-term investments for individuals. The best part of mutual funds is that you have to just sit back and relax while a team of professional investors does all the research and investing on your behalf. Your money is pooled with many others to take advantage of investments you normally do not have access to. Mutual funds promote good habits of savings and investments. They have protected countless individuals against costly mistakes in the stock markets. It pays to invest in mutual funds because they have a way of spreading your risks into different assets and strategies. Investing in mutual funds helps you in getting you where you want to be.
Are Mutual Funds Risky?
Every type of investment including mutual funds involves some degree of risk. Yes, mutual fund investments are subject to market risks. But, remember, risk does not mean danger—it means not knowing what the future holds. When you invest, you are not managing your today's wealth; it is your future that you are really managing. Whether you like it or not you have to take some amount of risk. For without risk, there is no return. All mutual funds are not equally risky. You have a wide range; from very low risk to very high risk mutual funds to choose from. The investment objective, the investment pattern and its holdings determine how risky your fund is. Higher risks are usually taken with the expectation of earning higher returns. It brings along higher degree of fluctuation or volatility. If your holding period is long enough you can successfully overcome the short-term fluctuations thereby effectively managing the inherent risk. There are different levels of risk to choose from. You just have to figure out the level of risk you can comfortably take and invest accordingly.
Great Potential for Higher Returns
Mutual funds do not guarantee returns. You must invest in mutual funds because they have great potential for generating higher returns for you than something that is guaranteed. Although they do not offer fixed returns, mutual funds have been gaining popularity over the past two decades. Mutual funds have created wealth for retirees, senior citizens and generally cautious investors who seek safer investment options. It pays to invest in mutual funds because they have proven to be profitable long term investments. When investing in a mutual fund you must be sure that the investment period for the mutual funds you choose matches with your investment time horizon i.e. your investment choices in order to achieve your investment goals must match with the time horizon ideally suited for that fund.
Here are six of the things that can make mutual funds work for you.
1. Have a plan and stick to it
Why should you invest? One of the most compelling reasons is to create lasting wealth for yourself. Investing is essential in getting you where you want to be. How should you go about investing your hard-earned savings? Have a plan and stick to it. Design a portfolio you are not likely to trade. Build a portfolio you can live with. You must have a clear idea of reasonable returns you can expect to achieve over the period of your investments and the level of risk you can comfortably take. As H Stanley Judd said "A good plan is like a road map, it shows you the final destination and usually the best way to get there."
Steadfastly hold on to your investments till you achieve your goals. Investing in absence of an investing policy reduces decision making to an event-driven process of chasing short term results. The absence of a plan steals attention away from your investment objective thereby giving up on the prospects of profitable longer term returns on invested capital. Look before you leap.
2. Asset Allocation: The secret for wealth creation
How should you balance the risk versus reward equation? Asset allocation is all about spreading your investments across equity, debt and cash in order to suit your risk profile, investment objective and time horizon. Asset allocation is the single most important determinant of your investment success. It is the very foundation for constructing and managing your portfolio. A study of 82 large multi-asset US pension funds found that asset allocation accounted for 91.5% of their portfolio returns.
Basic Asset Allocation Model
Table I: The Nature of Annual Returns
| Year | Equity | Debt | Year | Equity | Debt |
| 2002 | 3% | 23% | 2007 | 55% | 7% |
| 2003 | 72% | 12% | 2008 | -52% | 27% |
| 2004 | 11% | -1% | 2009 | 76% | -6% |
| 2005 | 36% | 6% | 2010 | 18% | 6% |
| 2006 | 40% | 6% | 2011 | -25% | 6% |
Table II: The Power of Asset Allocation
| Value of Rs.100,000 invested . . . |
| Allocation % Equity / Debt | 5 yrs 2003-2007 | 5 yrs 2007-2011 | 10 yrs 2002-2011 |
| 100 / 0 | 563443 | 115885 | 433895 |
| 75 / 25 | 409721 | 146130 | 452185 |
| 50 / 50 | 290696 | 163819 | 410782 |
| 25 / 75 | 200333 | 168799 | 335319 |
| 0 / 100 | 133306 | 161847 | 248013 |
For Table I & Table II
Equity = Nifty Index, Debt = I-Sec Sovereign Bond Index
Please Note: This is historical data for illustration purpose only.
Past performance may or may not be sustained in future.
3. Returns expectation
Any investment programme is likely to work better if you expect normal and average returns. As Benjamin Graham, one the greatest investors ever said, "To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." It pays to have normal and reasonable expectations from your mutual funds. The biggest pitfall for you as a mutual funds investor is to demand more than average returns from your mutual funds. It is a trap which shall take you down the wrong path with undesirable results. You can happily accept "above average" returns if they were to happen in the course of your investments. But, have a clear understanding that such high returns do not go on forever. Remember, in every mutual fund advertisement the following warning appears. "Past performance is no guarantee of future results." Please believe in it.
4. Invest, only for the long-term
Mutual funds have proven to be profitable long-term investments. Be ready to commit for five years or more. The odds are against you in the short-term, but, in the long run, time plays a vital role of reducing risk and enhancing your returns. The average long-term experience in investing is never surprising. But, the short-term experience is always surprising. Once you have paid for the risk, it is always a good idea to stay on for the returns. Moreover, as a long-term investor, the "Power of Compounding" is your best friend. (Albert Einstein described it as "man's greatest discovery"). It can most certainly create lasting wealth for you.
5. Periodically review your portfolio
It pays to periodically review the progress of your mutual funds portfolio against your investment goals. However, it is not advisable to closely monitor your mutual funds on a very frequent basis. Remember, your mutual funds are not going to perform any better just because you are tracking them very closely. But, on the contrary, it is easy to be unnerved by short-term fluctuations. You commit mistakes by taking impulsive decisions.
Frequently chopping and changing works against your investment objective to allow returns to compound over time.
6. Rebalance your portfolio
Equity funds and debt funds perform differently at different times. Thus the proportion of debt and equity in your portfolio keeps on changing. It pays to rebalance your portfolio by selling the asset class that has done well and buying the asset class which has suffered a price decline in order to restore your asset allocation back to desired levels. Review your asset allocation every six months or once in a year.
Here's wishing you Happy Investing! & Many Happy Returns!!
Author - Nilesh Kamerkar , Managing Partner, Capital Partner Source - MLF
Best Regards
Prakash Nair
