Investing in Equity Mutual Fund is like taking a journey in a Taxi

Investing in Equity Mutual Fund is like taking a journey in a Taxi 

You must be finding strange at the above caption. Must be wondering what is the correlation between the two and how the two are comparable . Sometimes we understand a thing better if linked with some  vivid experience .

Let us assume I want to take a cab from Delhi to reach Agra . What are the things I am going to look at before selecting and going for the journey .

How quick and safely I can reach my destination .  I can not be unreasonable to think that a 4 hour normal journey will be covered in 2.5 hour or also not be accepting that it should take 6 hour . I have a realistic time expectation as to when I will reach . If I have targeted a particular time to reach I should start at right time. I don’t want to go slow and be late .But at the same time I might not be in hurry to reach as quick as possible  taking unnecessary risk but if I reach before time safely I would be happy.  In Equity MF investment like reaching Agra my long term goal could be  children higher education ,marriage, post retirement etc . I have targeted a level of return to match my cash flow requirement so must get that much at a right time. I should start investing well in time or have a realistic time horizon where I know I will get my desired return.  My expectation of return has to be realistic but in case I get more than what I realistically expected I would be happy .  

In our cab drive we know and are mentally prepared that at some places we will see heavy traffic and speed will be slow but also know that there will be places where car will speed up and earlier time loss will be compensated . Similarly in equity fund we should be mentally prepared that in between in short time duration sometimes return might be low as condition might not be favourable but again there will be good market scenario also where opportunities for earning higher return in the fund will come and earlier short term low or less return will be recovered .

Roads might be bumpy at some places and some place smooth . I want a smooth ride so expect the cab driver drive with caution at potholes and speed where smooth. Stock Market is also bumpy and we expect fund manager to protect downside when market is falling or volatile and when market moving upward take advantage of the upside . The overall ride is mix of both experience but the total experience ends up well and happy . Just like we expect cab driver to balance his overall drive looking at road condition we should expect the same from equity fund manager looking at the market condition and opportunities available.

Even if the car goes slow or some one overtakes it we do not change the car and shift to fast moving one  . Once we have decided after thorough diligence about the cab and driver we trust him and ride in the same car . In case of equity mutual fund also once decided after doing all analysis and diligence we do not keep on shifting between funds due to short term performance . In short term there will one fund overtaking other like cab but if we have conviction and evidence that the fund will deliver as per our expectation we continue invested . We can shift from one fund to another only when it becomes a non performer and something serious wrong and no corrective action being taken similar to when the car goes for a breakdown and change becomes imminent.

We might look at the cost but again for the sake of low cost we do not compromise on comfort and other thing . In equity mf investment also the cost has less relevance if that gets compensated by better return .

We look at the cab driver . If he is new we might be a bit hesitant but if he is experienced we don’t hesitate . Again when one is selecting a equity fund the experience, expertise of fund management also needs to be looked before making an investment decision . In a cab you don’t know from where some rash driver can hit you , suddenly caught in traffic jam and at times driver take diversion route ,don’t know when the car ahead puts brake and your driver need to be alert to put brake in time etc . Similarly equity investment is subject to so many risks , market risk , company risk , business risk etc and a skilled prudent fund manager is expected to manage all risk to see that the portfolio is least hit and damaged . He has enough tools and research based inputs which helps him to tackle various risks .

We do evaluate the interiors, comforts , speed , seating comfort .  That makes the ride happy and peaceful. Similarly when investing in equity fund you look at asset quality , the various options , systematic approaches of investment , transfer and withdrawal, payment mechanism these provides you advantages over investment avenues .

Winning Investment Strategy

Winning Investment Strategy

Lets look at some of the facts

·       

      Generally a youth starts earning at approx 23 years of age , normal retirement is approx 60 and with increasing longevity can live up to 80 years of age . It means approx 37 years of salary earning and 57 years of survival on total earning of which last 20 years when there is no fixed monthly salary earning .

·         Historical returns for a 1 year, 3 year or 5 year debt fixed return investment product has been between 8% to 9% . It might have gone 1or 2 percentage during higher inflation in past . When one looks at equity return the range could be any wild guess in short term positive or negative ( 1 year or less period ) but as one moves to longer period some pattern of fixed return emerges and from period 5 years onward the return has been generally higher than debt return and in the range of 15-20 % . Moreover the probability of getting expected higher return increases with time duration and it is almost 99% for 10 year and above investment horizon.

·         If we track bank deposit rate for 1,3, 5 and greater than  5 year periods one has seen that there is no extra return for greater than  5 year period investment . At times 5 year FD return is less than 3 year FD and also return on 5 year FD and greater than 5 year FD are same. It simply implies that there is no extra incentive for investment beyond 5 year investment .

·         In India the investment of individuals ( households ) in debt vs equity is approx 96: 4 i.e only 4 rupee out of total 100 rupee invested is in equity ( share or mutual fund ) and 96 rupee in debt ( bank deposit , fixed deposit, post office deposit etc ) .  

Lets look at investor attitude toward investment . Do they want return OF investment i.e NO LOSS or Return ON investment i.e GAIN. Off course first one is the basic minimum requirement which everyone wants .  Now we need to understand NO LOSS also .Is it capital getting back ( i.e if 100 rupee invested then should get back 100 at least ) or todays value worth of Rs 100 when invested which means taking account of inflation i.e if inflation has been 7% p.a then at least get Rs 107 after a year of investment .

If I look 96: 4 ratio ( Debt : Equity ) I feel most are satisfied with protection of value of money invested . Anything marginal above it is more welcome .  But question is how much more they can get .

Lets try to understand why there is no incentive for long term investment in bank FD . Bank deposit rate is based on repo rate which to a large extent is based on inflation rate and also economic growth ( GDP ) requirement . Bank rate can never be less than inflation else why some one will deposit to lose its money value . But at the same time as we are growing economy and there will be demand for money i.e loan requirement so Bank Loan rate has to be as less as possible . Competition and demand for loan decides bank deposit rate and bank loan rate .

So the best return one can expect from fixed deposits of Bank is few percentage more than inflation rate . It implies there is RETURN LIMITATION in debt investments .

The MINIMUM return from debt any investor looks is return OF investment where net return is positive i.e inflation growth is also taken care . This is the normal mindset . Why not ye dil maange more .

Every investor if desires MORE than this ABOVE MINIMUM but with no disturbance of peace of mind then he has to look where there is ZERO probability of return not going down from the MINIMUM . It means he has set a base return + more which is return ON investment .  When looked from debt perspective It has to be from where there is no extra incentive for debt investment ( i.e  5 year ) . It means if investment horizon is beyond 5 year investment asset should be in equity and not debt . Cross checking the same in equity investment i.e from where the 99% probability of base return + more starts it is 5 year .  The more the time horizon beyond this there is probability of higher consistent return in equity.

If wants to ensure more SAFETY AND STABILITY i.e more assurance from downside risk from equity investment one should invest through mutual fund route where research based investment decisions are taken and also diversification in many sectors and stocks reduces volatility in return .

Zee Business Money Guru 02 Nov 2015 Prakash Ranjan Sinha Nurture Indi...