One big mistake you can make when investing in a market that is scaling new highs is to invest in one of the past year’s best-performing funds.
Such funds often don’t manage to repeat their performance in subsequent years.
In every bull market, certain sectors lead the rally.
Funds top the charts by taking a heavy exposure to these sectors.
When the markets correct, these sectors often get hit hard and sometimes stay depressed for years.
The top performers of the bull run then suffer.
The Funds should not be selected based only on a single year’s performance. Look at how it has performed across different market environments and cycles. Besides its performance in a bull market, also check whether it has done a good job in protecting downside losses in falling markets.
1. Lump sum riskier than SIPs
Another mistake investors commit is to invest a lump sum during a bull run.
“With a lump sum investment, you don’t get the benefit of averaging down your cost of purchase of units when the markets correct,” says Nilesh Shah, managing director, Kotak Mutual Fund.
Even if an investor had put money in one of 2007’s top performing funds, s/he would have suffered in a big way only if s/he had made a lump sum investment.
Her/his SIP returns over five years would have been reasonably good in many of these funds.
2. No sector funds, please
Investors entering the markets during a bull run should also avoid sector funds.
In 2007, the infrastructure sector was at the forefront of the rally. The average one-year return of these funds stood at 81.45 per cent at the end of 2007.
Over the next three years, however, they gave an average return of only minus 7.68 per cent, and over five years, only minus 8.07 per cent.
“Avoid sector funds. We have seen investors lose money in technology funds in the late nineties and in real estate, infrastructure and commodity funds after 2007. These funds are far riskier than diversified equity funds,” says Rajeev Thakkar, chief investment officer, PPFAS Mutual Fund.
3. NFOs aren’t cheaper than existing funds
Investors should also avoid new fund offers, NFO.
Typically, when the markets are doing well, fund houses try to raise funds through NFOs by capitalising on investors’ bullish sentiments.
With Sebi turning stricter about permitting NFOs, not too many sector fund NFOs have hit the markets during this rally.
However, fund houses are launching closed-end funds.
Avoid them.
Stick to open-end funds where you can see the fund’s track record.
Investors entering equities now should have a long horizon.
“Invest for at least 7 to 10 years so that you have time to recover even if the markets correct,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.
4. Stay diversified across asset classes, and equity segments
If you had decided on a 70:20:10 allocation to equities, fixed income and gold, don’t change it and go overweight on equities just because this asset class is outperforming currently.
Keep rebalancing at regular intervals by selling the asset class that has outperformed and investing in the classes that have underperformed.
Within equities, allocate across categories. You could, for instance, have an allocation of 70:20:10 to large-, mid- and small-cap funds.
“Have a bigger allocation to large-cap funds because these stocks tend to be more resilient. Don’t allow your allocation to mid- and small-cap funds to rise excessively as this is where valuations have turned frothy. Smaller companies also tend to suffer more during a downturn,” says Dhawan.
Balanced funds or dynamic equity funds (which reduce exposure to equities when valuations are high) can be good ideas.
Any money that investors need for, say, their child’s college education within a year, should be pulled out of equity funds and put into fixed-income instruments right away.
Source : Business Standard
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