Warren Buffet once rightly said, “We don’t have to be smarter than the rest, we have to be more disciplined than the rest.”
How would one do safe investments with not much of risk associated to it, especially in a scenario where there are ample investment instruments in the market?
What are the hidden costs associated with these instruments such as mutual funds? These are the questions that haunt us even before we start pooling a small share of money for investment.
Retail investors or individual investors have to be aware of the disadvantage that they have, which is the information disadvantage. Information always reaches us later than it reaches for somebody who makes a living out of investing, those who pay for such timely information.
Portfolio managers and traders always claim to provide you free advice for your stocks or mutual funds, but one should not always go by it.
Pointers to keep in mind
Asset class
Different asset classes give returns in a different way. If you own a flat, it can fetch you regular rental income, only if you can maintain it.
If you have an FD, you can be assured of interest payments unless the worst happens and the bank becomes insolvent.
Buying stocks can also give you a healthy price appreciation, without the fuss of owning a flat.
Time frame
Since different asset classes have different returns, one might need to keep the time frame of their investment in mind. A long-term investor seeks capital appreciation (owning stocks, property), but if your horizon is short, it might be better to seek assured returns (owning debt).
How do you know what is your time frame?
That depends on your goals. Paying for a child’s education, buying your own flat, buying a car are all set goals of different time frames and the priority for each differs at the same time.
Matching your asset class with your time frame—equities or properties for long term, debt or other safe assets for short term. This automatically means that as your goals get closer, your portfolio should become less riskier.
Do not keep all your eggs in one basket
To protect against risk, try to own a variety of asset classes, along with varying their proportion in your portfolio depending on how far and how big your goals are. Some money in a very safe asset (like FDs or gold).
Things to watch out for in mutual funds:
- Expense ratios
This is what you pay the mutual fund in order to use their expertise. Usually expressed as a % of asset value (invested amount). ETFs (Exchange Traded Funds) can have low or no expense ratios since they are not actively managed. Passively managed funds (i.e., no frequent trading activity by the portfolio manager) can also have low expense ratios.
Whether one should or shouldn’t pay for active management and if it is worth, it is an ongoing debate (though analysts vouch for it).
- Exit loads and entry loads
Also expressed as a %. Entry load is a charge you pay at the start of your investment, while exit load is what you pay when you decide that you want your money back. After a lot of capital appreciation (after many years), an exit load may hurt a lot more than an entry load.
- Dividend or growth
D is Dividend, G is growth. A long-term investor wants to keep investing his/her returns (dividends) back into the fund, aiming for better capital appreciation in the long term, aided by the effect of compounding.
An investor who wants a recurring income (for instance, a retired person) would want to get returns back in cash.
- Choosing funds:
Some funds are aimed at short-term returns, while others are aimed at long-term returns. Some aim for diversification and safety, others can be much more risky.
A large fund size (which means many people trust them) and good past performance is worth knowing, but keep in mind that past performance may not be an indicator to the fund’s future performance.
Use all the above points (especially expense ratios) to pick a good fund.
Generic solution
Analysts and people in related fields are ethically bound not to reveal their current opinions. As a result, when you ask an analyst or person in the related field he/she can never provide you with a solid point blank answers but would definitely help you with partial view or generic solution.
At the same time, analysts and people in related fields can also be highly opinionated or biased towards a particular style of investing or asset class.
Try to read between the lines and ask as many questions as you want and then come to a sensible judgement and try to split your funds so that you are under a less riskier zone.
(With inputs from Equity expert Arun Sadanand)