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Mutual Funds: A Few Good Practices to Know

, April 23, 2021, 0 Comments

In this article we will be continuing our discussion on a few good practices when investing in Mutual

Avoid Excess Speculation

This is perhaps the most important lesson I have learnt when investing in Mutual Funds and hence, I will be devoting a significant amount of time to explain its importance.

I have seen a growing tendency amongst friends and relatives to regularly “book profits” on their MF investments (often liquidating the entire scheme itself) for no other reason than the fact that they have made decent returns and that they now believe that they will get an opportunity to reinvest at a much lower price in the future.

In my experience, these “lower entry points” very rarely ever come rendering these activities pointless and often counterproductive to long term portfolio appreciation.

Reports show that in the month of December 2020, Equity Mutual Funds witnessed outflows for the 6th straight month even as markets scaled fresh highs. As per data released by the Association of Mutual Funds in India, investors pulled out net Rs. 10,147 Cr. From equity and equity-linked mutual fund scheme in December. In fact, as per the article, for the 1st 9 months of this current financial year, equity and equity-linked mutual funds have seen net outflows of Rs. 27,293 Cr. vs a net inflow of Rs. 83,788 Cr. for the entire year ended March 2020.

Two possible explanations have been offered to help explain the above phenomenon. The 1st being that investors have chosen to switch to investing directly in stocks or have shifted to other asset classes such as real estate. The 2nd more widely touted explanation is that investors have turned cautious and have chosen to book profits on their investments anticipating a better entry point in the future.

While there is nothing wrong with trying to protect your hard earned capital I feel the need to stress the importance of sometimes ignoring the “white noise” around us and not give it to wild speculation.

To illustrate this point; let’s assume Mr. A invested ₹5 lakh on 31st March 2020 when the Nifty closed at 8,597 points (for the purpose of simplicity, let’s also assume that he has invested in a passive Nifty50 Index Fund). On 31st October 2020, the Nifty closed at 11,642 points a gain of 35% or a cool ₹1.8 lakh profit on his investment. With the US elections due in November he keeps hearing about heightened volatility and perhaps a fall in stock prices. Thus, he chooses to liquidate his investment and wait for a better entry point. Well, unfortunately for Mr. A, the Nifty logged one of its best monthly rallies of 11.4% in the month of November to close at 12,968 points. To make matters worse, between 31st October and 31st December, the Nifty rallied a full 20% to end the year at 13,981 points a gain of 63% from Mr. A’s entry point on the 31st of March. Thus, Mr. A’s 35% gain of ₹1.8 lakh as on 31st October 2020 would have been 63% on 31st December 2020 or ₹3.1 lakh. Ouch!! Add to this the any exit loads due to redeeming before a year as well as 15% Short Term Capital Gains tax and Mr. A’s net profit has just shrunk by that much more.

The above illustration is an extremely simplistic example. For starters it assumes that such rallies will last indefinitely which is certainly not true. However, the underlying message still holds that while there will always be corrections or even more pronounced falls, it does not do any good wildly speculating on them. Unless you can predict them with reasonable certainty, you will find that in the long run, you are much better of holding onto your investments.

If one views the historical charts of the Sensex or Nifty, it is clearly obvious that while there have been certain blips in the form of corrections and sometimes more prolonged crashes, the broad trend has always been upwards. There may be another fall just around the corner in which case you can always use it to deploy fresh capital to your portfolio. We recently witnessed such a fall during the last week of January 2021 during the weeks leading up to the Budget. Between January 20th – January 29th, the Sensex and Nifty both declined 3,506 points and 1,010 points respectively a fall of approximately 7% each in a pre-Budget sell-off then rallied sharply post its announcement to erase all losses and hit record highs.  These instances teach us to, as a general avoid speculation and only redeem your investments if you have a high conviction or have a requirement of funds.

It is important to understand the difference between selling based on speculation and selling based on analysis. Speculation is not based on any analysis or reasoning. To put it bluntly, it is a gamble where the outcome is a coin toss. On the other hand, when you take an informed decision based on reasoning and analysis, you start making decisions based on facts and not conjectures. The analysis need not be extremely complex, however, it must have solid reasoning and logic behind it. In the above e.g. our poor friend Mr. A did not have a justifiable reason to sell other than his speculation on the outcome of an event and its effect on markets.

If you have done your homework and feel it is time to exit, then, by all means, that is exactly what you must do which brings us to our next point:

Don’t Be Afraid to Reallocate or Exit

People often choose to book profits on their winning investments be it stock or mutual funds while sticking with their underperforming schemes in hope of a turnaround. To quote Warren Buffet, “Selling your winners and holding your losers is like cutting the flowers and watering the weeds”.

To achieve true long term returns, you must regularly review your portfolio. Take note of those schemes which have consistently outperformed, and those which have consistently underperformed. This exercise should be performed over a period of time, preferably a few months at least. Remember, we have learnt that all schemes may go through a temporary period of outperformance or underperformance. By observing their performance over a longer period of time we can help eliminate being swayed by these temporary blips and see the true picture. If our research concludes that it is time to sell, then that is exactly what we must do no matter even if at a loss.

Remember, profits, losses are simply outcomes which are not in our control. Neither do we have any control over market movements. So let’s not spend too much time trying to make decisions based on things we have not control over. What is in our control, is our effort, our discipline and our research and thought process. As long as we apply all of these in the right direction consistently, I am sure over time, we will begin to see the payoff.

The Benefits of Investing Monthly

It is always a good idea to invest a fixed portion of your monthly salary in mutual funds. This investment need not be through an SIP route as you may want to invest the same amount every month but allocate it differently each month. Whether investing through SIP or lump sum, I would also advise you to gradually increase your investment amounts as your salary increases. This way, you also develop the habit of saving and investing regularly. Thus, as your wealth increases, so should your savings and investments.

When I started working on this project, my aim was to help demystify mutual funds, and also share my own experiences and observations. Besides explaining what are mutual funds, and the various types of funds, we have also covered the various tools an investor can use in their research and also common behavioural biases which we should avoid as well as certain habits we should inculcate to aid our investment process.

It is important to temper our return expectations with mutual fund investments as these are not get rich quick schemes (very few investments are for that matter). The trick is to identify those funds that have the potential to generate consistent returns and stick with them. This process of identification is unlikely to happen overnight but as you stick with it over a period of time you will begin to see benefits compounding.

On this note, I would like to end this series. I hope that you have found it useful.

Read also:
A Beginner’s Guide to Mutual Funds and Why You Should Consider Them
Different Types of Mutual Funds and What They Mean for Investor
Mutual Funds & Terms associated with it

The opinions expressed in this article are the author’s own and do not reflect the view of MarketExpress – India’s first Global Analysis & Sharing Platform or the organization(s) that the author represents in his personal capacity.

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