Portfolio Ideas. When do you invest in equity MFs?

The NSE 50 Index has climbed about 30 per cent since December 2016.

This steep rise in asset prices has raised a question: Is it risky to invest at the current price levels?

In this article, we address the broader issue: When is it appropriate to invest in mutual funds?

As you will see, the time horizon for your life goal plays an important role in your purchase decision, not the price levels in the market.

Accumulate wealth

We divide your personal finance decisions into two — your goal-based (core) investments and your trading (satellite) portfolio. Your core portfolio’s objective is to accumulate wealth to achieve your life goal.

For this purpose, you have to invest in equity and bonds. Your bond investments will provide certainty to the cash flows.

You have to invest in equity to earn a return higher than inflation.

You should treat your goal-based investments just like your gold purchases. You consider gold as a consumption asset, not as an investment asset.

Similarly, consider buying mutual funds to ‘consume’ the sale proceeds to fund your life goal.

Your objective is not time the market but to continually accumulate wealth to achieve your goal. Agreed, you are exposed to downside risk.

But if you do not continually invest in equity, you are sure to fail in accumulating the required wealth!

You should, therefore, set-up a systematic investment plan and stay in the market through the time horizon for your life goal.

Moderating regret

By the same logic, your decision to redeem should be obvious: Sell your units when you need the money to meet your life goal. Unfortunately, your decision to sell may not be easy.

Consider the technical reason. It takes little effort for the market to wipe out your unrealised gains.

You have to, therefore, protect your unrealised gains through the time horizon for your life goal.

On the behavioural side, you become anxious to protect your wealth as you approach the end of the time horizon for your life goal.

The last five years (also called the “anxiety zone”) is crucial; you have limited time to recover losses suffered during this period.

Hence, you may want to redeem some of your units, especially during the anxiety zone to lock into your gains.

But that is easier said than done. What if you redeem your units and the market moves up subsequently?

To moderate regret from your selling decision, develop pre-determined rules. You could employ a combination of two rules if you invest in the growth option of an equity fund. First, you could sell some units when the fund pays dividends to its unit-holders; for that could be an indication that the fund manager considers it better to return profits to the investors than to reinvest in the market.

And second, create your own rule. For example, you could redeem some of your units when unrealised gains exceed your expected return in a year.

You should have your spouse or friend implement the rule to avoid regret you may suffer from taking such active decisions!

The writer is the founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in

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