Mar 9, 2010

5 things you should avoid while investing in Equity mutual funds


Ok, choosing the best equity fund or ELSS for the purpose of investing in mutual funds is no-doubt very important but what are the other important considerations to be kept in mind while investing in them.

So, continuing the discussion, this post is going to tell you about 5 things to avoid while investing in equity mutual funds.

5 things to avoid while investing in Equity funds:

1. Avoid Duplication
Before Investing in a good mutual fund, you must look at its
top 10 stock holdings and also top 5 sector holdings...Why? To avoid duplication. The basic purpose behind investment through the medium of mutual funds is to diversify the investment portfolio. Diversification helps in de-risking of stock portfolio but having multiple funds in your portfolio with the same stocks defeats the purpose of diversification i.e., your investment portfolio becomes as good as an undiversified portfolio.

Therefore, while investing in equity funds, give a look at the underlying stocks. Let’s say you’ve all the three top / best performing equity funds in your portfolio. Further suppose that out of the top 10 stock holdings six (say, ICICI Bank, SBI, Reliance Industries, Infosys, HUL and HDFC) are common to all the three funds; it’ll be as good as investing in just one of the funds.

First ask yourself, why do we need to go for multiple funds? By investing in similar schemes, you don’t do much of a diversification in the real sense. The best way is to have two or at the most 3 top rated equity diversified funds (multi / large Cap) having different stock portfolio and / or 1-2 equity diversified (mid & small Cap), according to your risk profile (remember mid & small cap funds are riskier than multi / large-cap funds).


2. Avoid Laggards
Rather than chasing top-performers, it is more important to look for consistent good performers and avoid non-performers. In other words, avoiding laggards or weeding out consistent under-performers is more important than running after the best equity mutual funds.

First ask yourself: Is it really important to run after the best performing funds? Is it worth the time, effort and cost involved; or, is there any better way to make your mutual fund portfolio better & efficient?

As already explained in the earlier post, the best is always a relative term (there is no absolute best) and this relativity can make your performance look pale not because you’re not doing good but others are doing better than you.

There are two implications:
a) We should consider both relative as well as absolute performance.
b) It is more important to avoid the laggards / worst performers than to choose the best performer.

You’ve nothing to worry about so long as your portfolio contains 4 & 5 rated funds. If a fund is rated 3 star, then hold on and keep it on your watch list. No urgency to dump it immediately. If a fund is rated 1 star or 2 star, it shows consistent poor performance. You must act immediately to weed it out.


3. Avoid Sectoral & Thematic Funds
Avoid sectoral and thematic funds because these are the riskiest equity funds. If you’re already invested in them or would like to invest in them, restrict your exposure to a maximum of 10%.


4. Avoid New Funds
First never invest in a NFO. Second, go for a diversified equity fund with a track record of 5 or more years and having 4 or 5 star rating. You might also consider other 5 star rated funds having track record of less than 5 years. But it is better to avoid any fund less than 3 year old.


5. Avoid Frequent Churning
Know that there is a cost attached to shuffling portfolio. You should have clear reasons for reshuffling the portfolio. Simply because the fund ratings have dropped from 5-star to 4-star or from 4-star to 3-star is not a good enough reason. In other words, so long as your portfolio doesn’t hold any 1-2 star rated fund you’ve no reason to worry and there is no need to reshuffle funds. As already discussed, chasing short term top performance is a mirage.


Also see:

1. How to choose best equity funds

2. 10 Mutual Fund investing principles

3. 5 guidelines for investing in ELSS

7 comments:

  1. I am looking for an online portfolio tracker (preferably free) to track my personal investment (equity, MF, ppf, FD etc.) portfolio. Some of the options that I looked into are tracker provided by moneycontrol, valueresearchonline.

    Any pointer on this ?

    ReplyDelete
  2. BDeb,

    I recommend trying both and selecting the one which suits you.

    ReplyDelete
  3. First of all..fantabulous post you have...wonderful explanation..

    Sir,
    I am looking for long term investment in two mutual funds which are Franklin India Bluechip Fund(Growth) and BSL frontline Equity Plan A(G).
    My mode of investment will be SIP...
    Please let me know is my selection correct? if not please let me know which to remove /Add?

    Thanks,
    Nitin Sharma

    ReplyDelete
  4. Nitin,

    Both are good funds… while Franklin India Bluechip Fund (growth) is currently rated 4-star, BSL Frontline Equity Plan A(G) is rated 5-star by Value Research.

    ReplyDelete
  5. I am looking for long term investment(3-5 Years) in three mutual funds which are Reliance RSF - Equity (G),ICICI Pru Discovery Fund (G)
    and IDFC Premier Equity - (G)

    My mode of investment will be SIP monthly 2000 Rs....

    Please let me know is my selection correct? if not please let me know which to remove /Add?

    Thanks,
    Chirag Patel.

    ReplyDelete
  6. I'm very much new to SIP option and its benifits, but i'm interested to invest 10000 pm in ELSS/Equity schemes with SIP option for next 15 years. But i dont know which funds are best.

    1. Suggest me few good ELSS/Equity funds which gave better returns in the last 5 years.

    2. Can I invest the whole amount in 1 fund or multiple funds? If multiple, what percent can be invested in which funds?

    3. Is there any chance for lose at the end of 15 years?

    4. Will I can get returns at the rate of 15-20% at end of 15 years?

    5. which option (dividend or growth) is best?

    Thanks
    Baskar

    ReplyDelete
  7. AnonymousJune 01, 2010

    good article
    advice on investment in index fund. is it worth at the present expense. i want to include in my core portfolio and am looking for banking BeEs fund or HDFC sensex plus plan. kindly suggest if better funds are there.

    ReplyDelete

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