Here is what you need to know and do to be a successful equity mutual fund investor. This also applies to the long-term direct equity (stock) investor.
Understand the true nature of the stock market: All those stories of “compounding” that you have been fed do not pan out in real life. See: Don’t get fooled: Mutual funds have no compounding benefit!
Equity investing is like claiming a staircase in which you cannot see the next step and do not know how high or low the next step will be! The next step could arrive the next day or take years. See: Are you ready to climb the Sensex Staircase?! And Sensex at 50,000: lessons from the 42-year journey
The worst mistake you can make is to look at the last 1-year, 3-year returns, etc. and assume the subsequent 1-year or 3-year returns will be similar after you start investing. This applies to both good and bad past performance.
When the mutual funds say, “past performance is not an indicator of future performance”. They truly mean it! Believe them!
So, the simple secret is you must be prepared to face extended periods of poor returns and wait for a few good years here and there to change your life. Otherwise, do not invest in equity. See: 44-year Sensex return is 17%, but half came from just four years! Also, 15 years of mutual fund investing: My Journey and lessons learned.
First-time investors: Never invest in equity funds if you need the money within the next ten years. Maybe we can relax this for experienced investors, but it depends on the experience. So, I would be wary.
Most people unlucky to experience fantastic returns in the first few years of their investment journey (yes, you read that right) often assume that the rest of the trip will be or they will be successful if they invest for shorter durations.
Even for the “long-term”, do not go overboard on equity. There is no need to exceed 50-60% equity allocation. The rest should be sound fixed income.
Do not assume direct equity portfolios outperform mutual funds. There is no meaningful way to measure this other than anecdotal evidence.
Do not assume active mutual funds are better than passive mutual funds. The data says active funds struggle to beat the index consistently in at least half of most mutual fund categories.
- Be it large, mid, or small cap funds*, only half the funds in a category can beat their benchmarks.
- * In the case of small caps, the funds easily beat the small cap benchmark but fail to beat a mid cap index or Nifty Next 50, which is just as bad.
There is no set of best funds or ideal mix of funds. You can choose any set, active or passive or active + passive and build a corpus required for your future goals.
Equity investing without a well-defined goal or target corpus is like travelling in a rudderless boat.
Never assume that long-term investing will always be successful! See: Long-term investing in equity comes with no guarantees of success!
Long term investors must have a solid systematic risk management plan by gradually de-risking their equity exposure. Our research – explained in the goal-based portfolio management course and incorporated into the freefincal robo advisor shows that this has more than a reasonable chance of success regardless of market conditions. This is also explained here: do not expect returns from mutual fund SIPs! Do this instead!
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About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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