Which was your first equity mutual fund?
Mine was an equity fund from Fidelity about 17-18 years ago. I picked up this fund after reading the best-selling book “One up on Wall Street” by legendary fund manager Peter Lynch. During 80s and 90s, Lynch worked as a fund manager with Fidelity. I was so impressed with his writings that I picked up a fund from Fidelity AMC in India. Yes, Fidelity had presence in India and later sold their business to L&T MF. I don’t remember when I exited this fund but am sure the fund helped me learn a few things about how markets work.
Well, at least for us (existing equity MF investors), we don’t have to grapple with this question anymore. Whether that first fund turned out good or bad for us, we have already taken that first step and moved ahead.
However, there are still many young investors who are still figuring out their first mutual fund to invest in.
In this post, I will share my thoughts about how you can go about selecting your initial set of funds. My approach is for relatively conservative young investors. It is for investors who see value in taking a portfolio approach to investments. For long-term investors who understand that managing own behaviour is as important over the long term as selecting good investments for your portfolio. While I have used the words “conservative investors”, this approach also requires you to take risks and you can lose money.
This approach is NOT relevant for investors who are already seeking advice from an investment advisor. I believe your advisor would already be structuring a customized portfolio for you in line with your risk profile or financial goals.
This post is NOT for investors who are looking for maximum returns. This approach will only disappoint you.
This approach is also NOT for older investors whose portfolio construction may require much greater nuance. While “young” and “old” is subjective, investors over 35 years may have to give greater thought to their portfolio construction than the simple approach I suggest below.
You can’t invest on borrowed conviction
You can’t invest in the stock markets for 30-40 years on borrowed conviction. You must have your own conviction. And you can’t develop conviction by reading books or browsing through social media feeds or writing on prominent people from the investment community. Not saying, you must not read. You must read and read a lot. It always helps to read about stock markets history. Helps you plan and manage better during adverse phases.
However, there are a few things you simply can’t learn by reading. As Mike Tyson said, “Everybody has a plan until they get punched in the pace.”
You learn and develop conviction by getting your hands dirty. And experience is the best teacher.
You learn by seeing the value of your investments fall sharply, recover, and reach greater heights. When you have seen that happen once or twice, you grow more confident. You develop conviction.
Conviction is super critical in making your bets meaningful. You can’t eat CAGR or XIRR. Investing 5% of your net worth in the stock market won’t change your financial lives meaningfully.
By the way, stock markets are not as isolated play. The performance of Indian stock markets is simply a reflection of the performance of the underlying economy and its long-term growth prospects. Hence, you must also have conviction about the long term prospects of Indian economy.
Picking your first equity mutual fund: 3 important aspects for new investors
#1 Getting comfortable with volatility: No matter how inconvenient adverse market phases are, it is important to go through ups and downs. No better way to do this than by investing in an extremely volatile fund. A midcap or a small cap fund comes to my mind. A Nifty Next 50 index fund would also be a good fit here.
#2 Appreciate the benefits of diversification: Eventually, you will understand the value diversification adds to the portfolio (the markets will teach you). However, the sooner you do it, the better. It is easy to get carried away during market booms. During such times, the appreciation of risk goes down. And investors are comfortable taking riskier and riskier bets. And such bets are likely to be in domestic equity funds. To diversify, consider adding a debt fund, or a gold fund/ETF (or sovereign gold bonds), or even a foreign equity fund. You can also consider an asset allocation fund. Now, these funds will provide you different levels of diversification in the portfolio. I leave the exact choice to your judgement.
#3 Avoid scars during the early part of the investing journey: Because initial setbacks can make you wary and send you away from the equity markets for a long time. If you are young, time is your greatest asset. Don’t frisk away this advantage. You don’t want to stay away from the markets just because of the initial setbacks. For that, you just must ensure that setback is not too big. A relatively stable fund such as Nifty 50 index fund or a balanced advantage fund will help here. Now, these funds are equity funds and hence will be volatile too. But not as much as a midcap or a small cap fund.
While I would prefer that young investors also learn the power of low-cost passive investing, this aspect can be learnt or appreciated later.
If you look deeply, all (3) points are related. (1) is to help you appreciate the massive returns potential of the equity markets. However, there is no free lunch. High return potential comes at the cost of higher risk. Mid and small cap are extremely volatile. (2) and (3) are the hedge against the shocks from (1).
(2) also helps in (3). By diversifying your portfolio, you reduce the odds of massive setbacks to the portfolio.
Invest by way of SIPs
For (3), since the intent is to prevent deep scars, it is better that you invest by way of SIPs. Avoid lumpsum investments. Do not try to make too much money too quickly. You have a long investment life ahead of you. Such opportunities will come many more times in the future. If you are young, volatility is your friend.
What should be the breakup between the 3 types of funds?
I don’t have an objective answer to this. You can decide the initial percentage based on how much risk you want to take. You can fine tune the percentages later.
Usually, when I am confused, I take an equal weighted approach.
Why make this so complex?
Not an unfair question.
You may argue that picking up a Nifty 50 index fund or a balanced advantage fund (as mentioned in point 3) is a good way to start. And you do not need (1) and (2). I agree. However, my limited experience is that many investors want to eventually graduate to have exposure to riskier products (mid and small cap funds) as well. Plus, investors also take time to appreciate the benefits of portfolio diversification. So, when you must add these funds later, why not add them now and not 5 years later? Let the learning begin now.
There is no “One-size-fits-all solution” when it comes to investments and personal finance. You don’t have to agree or disagree with my thoughts here.
This approach is NOT so much about earning very good returns. It is more about learning how markets behave and understanding your own behaviour during various market phases. This is only to prepare you for the many years of investing that lies ahead of you. This can be your initial portfolio. Once you grow confident, you can refine your approach and chart out a different investment path based on your risk preferences and financial goals.
What do you think?
Disclaimer: Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investment in securities market is subject to market risks. Read all the related documents carefully before investing.
This post is for education purpose alone and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The securities, instruments, or indices quoted are for illustration only and are not recommendatory. My views may be biased, and I may choose not to focus on aspects that you consider important. Your financial goals may be different. You may have a different risk profile. You may be in a different life stage than I am in. Hence, you must NOT base your investment decisions based on my writings. There is no one-size-fits-all solution in investments. What may be a good investment for certain investors may NOT be good for others. And vice versa. Therefore, read and understand the product terms and conditions and consider your risk profile, requirements, and suitability before investing in any investment product or following an investment approach.
