Many investors often face the dilemma of how to go about investing in equities. Moreover, the mystique that surrounds the stock market often adds to the complexities of the decision making process. Financial advisor Hemant Rustagi highlights few dilemmas of equity investors and also advices on how to tackle them.
Equity, as an asset class, has an important role to play in the portfolio of a long-term investor. However, one has to be prepared to face market volatility from time to time to get the best out of one's equity investments. Besides, equities not only require time commitment but also a commitment to continue the investment process through market ups and downs. Another important aspect is to have the required flexibility to realign the portfolio in keeping with the changes in one's circumstances, the markets and the economic conditions.
As is evident, it is not enough to merely invest in equities. It is equally important invest the right way to build wealth over time. No wonder, many investors often face the dilemma of how to go about investing in equities. Moreover, the mystique that surrounds the stock market often adds to the complexities of the decision making process. Here are a few dilemmas of equity investors and how they need to tackle them:
Mutual funds vs. stocks
Investors often wonder whether they should invest directly in stocks or invest through mutual funds. While it is true that right stock selection and ability to analyze the impact of various events i.e. both national and international on the economic environment as well as profitability of the companies in the portfolio can ensure better returns, for someone who is not familiar, it can be quite overwhelming to do so. At the same time, if the stock selection is not good, one can get exposed to a much higher risk. Moreover, many investors either end up having very few stocks or a large number of stocks in the portfolio. While a portfolio that has very few stocks exposes an investor to the risks associated with a concentrated portfolio, over-diversification in a portfolio can result in poor quality stocks negating the performance of better performing ones.
This is where a professional and experienced fund manager in a mutual fund, who has access to research, can make a difference by making rational decisions about which stock to include in the portfolio and which to sell. Besides, investing in a mutual fund rather than directly in stocks has many other advantages. Apart from being an easy method of investing, it is much easier to track performance as one has to track only one price i.e. NAV, instead of several stock prices.
Systematic vs. lump sum investing
Over the last few years, systematic investing has emerged as the most favoured strategy for equity fund investors. A combination of factors such as increased volatility in the market, the need to build a corpus for long-term goals through smaller contributions, unpleasant experiences of investors to time the market in the past and incessant efforts of mutual fund industry as well as advisors to create awareness has contributed to the emergence of the phenomenon called systematic investing. By following a systematic approach to investing, one abandons any strategy that might control the timing of one's investment. In other words, only an investor who invests through SIP with a defined time horizon can benefit from "averaging" in a real sense.
On the other hand, investors who have a lump sum to invest often find it difficult to decide whether to invest systematically or invest in one go. Although for a long-term investor, making a lump sum investment is not an issue, it should not be the end of the story. If one is not sure about one's ability to invest on a regular basis, the right way would be to opt for a combination of systematic investing through a Systematic Transfer Plan (STP) and a lump sum investment. It is important because many investors have the tendency to chase performance in a rising market and hence quite often a major chunk of money is invested at the peak of the market. Besides, there is also a tendency to rely on short term performance of the funds that often takes investors beyond their risk tolerance levels.
Performance vs. Suitability
While selecting the scheme should ideally be the last step in the process of decision making, most investors make this as a first step. As a result, they end up investing in the funds that may not suit their objectives. Therefore, the first thing an aspiring MF investor needs to do is to establish what type of portfolio he wants to create.
Performance can be a useful tool for judging which scheme to get into. However, it is important to keep the performance in perspective. The objective should be to select funds that suits one's requirements depending upon one's investment objectives and time horizon. Even when one decides to invest in equity funds, the focus has to be on diversified equity funds that have a bias towards large cap stocks.
The exposure to aggressive funds like those investing in mid-cap stocks, opportunity and thematic funds can be increased gradually. However, these funds should never become the mainstay of the portfolio.