Avoid Taking Irrational Decisions

For equity fund investors, the going continues to be tough. It is apparent that the stock market will witness a lot of volatility over the next few months even though it is unlikely to go down much from these levels. No doubt, times like these can test the patience of the seasoned investors too. Such circumstances can create certain dilemmas in the minds of investors and compel them into taking irrational decisions. Let us discuss a few of these situations and analyse as to how these need to be tackled:

First and foremost, negative return from funds is perceived as poor performance. The fact, however, is that even the best of fund mangers are likely to give negative returns during periods where markets go down significantly. Besides, the time period considered also signifies the true level of performance. For example, short-term negative returns, in line with the market from a fund that has been doing well for years, means nothing and should be ignored.

Similarly, even a bad fund manager can give decent returns when the markets are doing well. Besides, a fund manger can enhance the returns of a fund in a good market by increasing the risk exposure. Therefore, one needs to go beyond the performance numbers to judge the skill of a fund manager. Remember, a fund’s successful track record can at best be a positive indicator, but not a guarantee that growth will continue at the same rate. The following factors are important in evaluating the performance of a fund:

Consider long term track record rather than short-term performance.
Evaluate the track record against similar funds.
Discipline in the investment approach is an important factor as the pressure to perform can make a fund manager susceptible to have an urge to change tracks in terms of stock selection as well as investment strategy.
The objective should be to differentiate investment skill of the fund manager from luck and to identify those funds with the greatest likelihood of future success. Avoid those funds that are showing very high past returns because of a very big but isolated period. Clearly, it is important not to depend entirely on the recent performance. To be a successful[PAGE BREAK]

mutual fund investor, it is necessary to have the right mix of funds in the portfolio. The right way is to decide the allocation to each asset class and then decide the funds for each one of them.

Secondly, while making investment or at the time of realigning the portfolio, not much emphasis is put on the composition of the portfolio of the scheme i.e. how much exposure the fund has to different market caps and what is the fund’s philosophy on this aspect. The market cap has a role to play in the kind of returns the stock might deliver and the risk factor or volatility that one may have to encounter from the stock.

As regards the allocation to each segment, there cannot be a standard combination applicable to all kinds of investors. Each one of us have different risk profiles, time horizons and investment objectives. Besides, the allocation may differ for an existing investor and for a new investor. While an existing investor needs to consider the existing composition, for a new investor the right way to begin is to consider well diversified funds that invest predominantly in large-cap stocks and have some exposure to mid-cap stocks. Another important factor is the current state of the market as well as how the market is expected to behave over the next 6 to 12 months.

It always helps if one takes the help of professionals to decide the allocation as well as to do some re-balancing from time to time. However, as an investor, you have an important role to play in this process as your outputs can play a crucial role in getting the allocation right.

Last but not the least, many of us often lose sight of our long-term objectives in order to tackle short-term uncertainties in the market. While at times it may look compelling to do so, one would be better off by focusing on longer term goals and sticking to the original investment plan. This can be achieved by examining various options rather than rushing to look for easier options.