Should one make his or her first investment in mutual funds? And in which funds?
Mutual funds work well for a first-time investor because they don’t have to try and look at the market dynamics of how it functions. A skilled fund manager invests money in a pool of stocks that are well researched. The manager aims to generate positive returns for an investor, while minimizing risks at the same time.
There are other benefits too – for example, first time investors who want to start small can choose to invest small amounts and can also go down the SIP route. This helps investors average out their returns over the long term.
As with investing in individual stocks, the stock prices, the company fundamentals and the market movements matter, with mutual funds, it’s important that an investor picks the right fund manager. Look for a manager who has a consistent long term track record and prefer to invest in a risk-averse strategy for a first-time investor. While it’s important to look at the past performance of the fund, it’s also essential to remember that past performance is not an indicator of how a fund is likely to do in the future. When it comes to markets, it’s important to remember that they are cyclical in nature. It’s highly likely that a fund that’s been a top performer for one year can take a tumble the year after. What’s important is the manager’s consistent approach when it come to managing a fund and his adherence to the fund’s philosophy.
We typically suggest that first time investors tailor their portfolio with a focus on a slightly lower risk. Balanced funds can give investors a flavor of equity as well as debt, taking on the role of basic asset allocation too. So, investors don’t have to think about how much equity and debt they want to hold as part of their portfolio. However, if investors choose to do their own asset allocation between equity and debt, we typically recommend a 70% exposure towards equity and 30% exposure to debt for an aggressive investor. This is typically applicable for people who have a higher risk-taking capability. For the moderate investor, we recommend that they bring down the equity level to 60% while for a more conservative investor, they could bring it down further to 50%, thus making a corresponding increase towards debt.
It’s also important that fund selection for first time investors is based on a combination of their long-term goals, their investment horizon and their risk appetite.
At Morningstar, we always recommend that anyone who wants to invest, does so over the long term. The power of compounding is something that only that patient investor can comprehend, and this is one of the most important factors to consider while investing.
Often, we have witnessed that investors redeem their investments in a rush, when they see a fund underperforming; without actually evaluating the reasons for the fund’s underperformance. The opposite also holds true, as investors rush to invest in a fund that they see is performing well. Investors who rush into investing in a fund that gives them blockbuster returns, often witness a neutral of a negative return simply because they joined the party a little too late.
Both these types of investors often incur losses – investors who opted to redeem when the market stumble most likely make mark-to-market losses in the process and redeemed just as the market would have witnessed a change in the cycle.
We think that timing the markets is not something that any investor can or should do, we’d much rather recommend that there is a strong growth in averaging returns and compounding an investors wealth.
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Articles authored by senior research analyst Kavitha Krishnan
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