Shares are a great way to invest and will provide in some cases “abnormal returns” over short to medium time periods. They also carry market risk as they can wash away the investments.
If you don’t want to increase your anxiety and settle for a bit lower gains, a better way to invest is in a pool of stocks. These instruments are termed as Mutual Funds or Exchange Traded Funds. The latter is similar to a mutual fund except the fact that it is actively traded in a stock exchange and can be bought or sold like ordinary shares.
Normalization of returns is not necessary a bad thing especially as it helps take away the risk and does not necessitate active involvement in the stock exchange and studying the news and company analysis in order to rejig your portfolio.
If you are a passive investor and would like to fire and forget in a script i.e. buy a stock and don’t look at the markets and let the stock perform the way it does over a 3-5 year period and withdraw the money when you need it, then that same stock that would have yielded unbelievable returns or loss would give you a standard return. In this case, again, Mutual Funds are a better choice.
Mutual Fund manager does the daily grind on your behalf and rejigs the portfolio of his shares so your investments performs better. Mind you, they are human too. This makes it important for you to select funds that are managed well. Most of these come with experience and learning from our own or others’ mistakes.
If you were ready to do a thorough research on the stock, you can use the same prowess to do a study of a good mutual funds that fulfills your investment style and objective and also provides you good returns. In case of active stock trading, your time involvement would be in days and weeks whereas for mutual funds you can review its performance and composition every quarter or couple of quarters.
I will briefly describe the different Asset Classes of Mutual Funds which mimic intuitively the asset classes (short term, medium term) for personal investments that we have discussed earlier.
Liquid
As the name suggests, this asset class of Mutual Funds invests your money in extremely liquid assets. You will have higher liquidity in these investments and the downside will be limited as they invest in more secured but lower yield instruments like government bonds & securities. You need to invest in this mutual funds to temporarily park your funds that are required for addressing a short term planned expense. They will definitely provide you higher returns compared to your savings account and give you the same liquidity.
Debt
This asset class invests money in debt instruments. These could be either corporate debt or personal debt. These carry a higher risk of default compared to liquid assets and also provide a higher return on your investment. There is a possibility of a dip if the corporate defaults and the mutual fund needs to write off their investment. In most cases, however, you will get a steady returns on investment in this asset class.
You may choose to park your lump sum money in Debt Mutual Funds in 3 cases:
- You can transfer smaller equal chunks of money in equity.
- You can invest in debt funds if you are happy with lower returns and do not want to take a higher risk.
- You can park your money and wait for the imminent correction in equity markets and redeploy it to equity when they are ready to go northward.
Equity
This asset class invests money in stocks. There are several subclasses depending on the objective of the investments. We have sector specific funds, funds tied to market capitalization, funds tied to specific indices and the list goes on.
When we evaluate the right fund for us, we would get confused with the number of choices in the menu card. There are several websites that provide an extensive analysis on the past performance of the funds. You can also compare the entry and exit load for each fund and can drill down to the details of the composition of the fund.
Depending on your risk appetite and sectoral preference and external factors at the time of making the decision, you can select the right funds. Be aware that past performance is not an assurance for future returns and you need to do your due diligence carefully before investing.
The safest bet is buying index linked funds. These usually have a low entry and exit load as fund management expertise is not of a paramount importance. The fund manager job reduces to ensure that the correct composition of index is maintained in the fund.
International Equity
According to a few experts, this is the riskiest class of asset under mutual funds. This is due to the fact that an additional unknown of currency fluctuations adds to the risk. While a few others say that this may dampen the risks. The fact that there are a few more unknowns related to transacting in a country that you aren’t as familiar as your home country makes them feel more risky. Like the equity schemes, these can be specific to a country or a region or linked to emerging markets or developed markets outside your home country.
When domestic conditions are not conducive or expected to worsen, it may be a good idea to keep a small portfolio in this asset class.
Read my blog: Should I Invest in Emerging Markets? – Myfinancejournal for additional information and considerations before you invest in this asset class.
Balanced
This asset class is a blend of equity and debt investments. The percentage of equity varies based on the investment objective of the mutual fund under consideration. As a general rule, equity would be about 70% and remaining amount will be in cash and debt. The reason is that debt will lessen the impact of negative returns from the equity portion. Needless to say that when equity goes up, the debt won’t increase as quickly and the returns would be lesser compared to pure equity investments. This is a sound strategy for investors that are more risk averse.
Here’s the caveat though – a mismanaged balanced fund may turn out to be more risky compared to a well-managed equity fund.
