If you are planning to invest for long-term financial goals such as your retirement, children’s higher education, buying a dream home, etc. then equity mutual funds are an excellent choice. Over the long term time frame, investment in equity mutual funds can outperform most other asset classes such as debt, gold, and real estate. Though equity as an asset class can be highly unpredictable in the short term, in the long run the power of compounding works in your favour and multiplies your wealth.
But successful long-term investing isn’t exactly a cakewalk. It requires creating a robust mutual fund portfolio by following a time-tested investment strategy that can maximise your wealth. Discipline and patience are also key because when it comes to investing in equity mutual funds, long term can mean anywhere between 5-7 years or more.
Often investors redeem their equity mutual fund investment after 2-3 years or as soon as market conditions turn bleak. This time frame is not enough to derive the full potential of your mutual fund portfolio. Remember that even though returns from equity mutual funds are market-linked and returns are not guaranteed, it must not be a cause of worry if you have a long-term investment horizon. The impact of volatility fades away when you invest for the long-term, and you are rewarded with superior gains.
In this article we will share some useful strategies to follow to maximise your returns from equity mutual funds over the long term:
1) Define your goals and time horizon
“A goal without a plan is only a wish”, so goes a famous saying.
Everyone has different financial goals such as retirement, children’s higher education, paying off debt, and so on. Setting a financial goal provides a purpose, meaning, and a roadmap to your equity mutual fund investment which in turn helps you to accomplish the envisioned goals. Your financial goals should be specific, measurable, achievable, realistic, and time-bound. In short, your financial goals should be S.M.A.R.T.
Once you have defined your goals, understand your time horizon i.e. in how many years would you need the money for the set financial goal. This will provide you with a better sense of the right amount to be invested, the type of investments to choose, and how much risk you should take on.
If this crucial task is sidelined you could end up being short of finances when you actually need the amount. You may even end up getting burdened with debt to meet the shortfall.
2) Know your risk profile
Many investors make investment decisions either driven by emotions, or influenced by peers/family, the popularity of the fund, star rating, top performers of the recent past, etc., hoping that it will help to generate high returns. But the fact is that different types of mutual funds offer different risk/reward profiles, and therefore, not all schemes may align with your risk profile. Assessing your risk profile will help you to select a suitable mutual fund scheme/s for your financial goals.
For instance, if you are an investor with a high-risk appetite and a long-term investment horizon of at least 3-5 years, equity mutual funds are ideal avenues. Similarly, within the equity mutual fund category you will find different sub-catgeories such as Large-cap Fund, Flexi-cap Fund, Mid-cap Fund, etc. that offer different risk-reward profile, thus allowing you to create a suitable portoflio. On the other hand, debt mutual funds are suitable for short to medium-term goals and for adding stability to the portfolio.
If investments are not done as per your risk profile, you are likely to discontinue your investment during extreme market conditions. This, in turn, could put a brake on the process of compounding wealth.
3) Diversify to create a robust portfolio
Diversification is the key to managing risk and optimizing returns. It is important to invest across various equity mutual fund categories and investment styles, depending on your risk profile and investment objective.
This way, if a particular market cap underperforms, the impact will be mitigated by a likely rise in other market cap segments. Accordingly, it will help reduce the concentration risk because no particular market cap can be an outperformer every year. However, ensure that you do not overdiversify by adding too many schemes to your mutual fund portfolio.
You can follow the ‘Core & Satellite’ approach to create an optimally diversified portfolio of equity mutual fund schemes. It is a time-tested strategy followed by some of the most successful investors. The term ‘Core’ applies to the more stable, long-term holdings of the portfolio, whereas the term ‘Satellite’ applies to the strategic portion that would help push up the overall returns of the portfolio across market conditions.
4) Prefer SIP over lumpsum
Historical data suggests that investing in equity mutual funds via SIPs have worked better as opposed to lump sum investment over longer time frames.
SIPs work on the simple principle of investing regularly in a disciplined manner that enables you to build wealth over a long period of time through the power of compounding. Investing via SIP also helps you mitigate the impact of market volatility; you buy less units via SIP when the market is on an upward trend and buy more units when there is a market downturn which averages out the cost of investment. As a result, SIP makes timing the equity mutual fund investment irrelevant, so you do not have to worry about dynamic market conditions.
When you invest via SIP, ensure that you do not discontinue or redeem your SIP investment if it does not work in your favour in the short term. Continuing your investment regardless of the market conditions helps you to average out the cost of investment over time and accelerates the compounding process.
5) Review your portfolio periodically
Investing for the long-term is important for wealth creation, but that does not mean you can follow an invest-and-forget approach. It is important to review the performance of your mutual fund portfolio periodically (at least once a year) to see if it is well-placed to achieve your goals. Reviewing the portfolio also helps you to accommodate any changes in your risk profile, financial goals, or investment horizon.
When reviewing your portfolio, assess if your equity mutual fund scheme is well-placed to protect against the downside risk during volatile or bearish market phases and also participate reasonably during market rallies compared to the category peers and the benchmark. In addition, check if rebalancing the portfolio from equity to debt or vice versa is necessary to align with your personal asset allocation plan.
It is advisable to start planning and investing for your long-term financial goals at the earliest so that you are in a position to maximise returns through the power of compounding. So, if you want to accumulate a large corpus, don’t wait for the market conditions to turn favourable. Once you begin investing via mutual funds, avoid getting swayed by the market noise and stay invested until you achieve the envisioned goal.
Remember the wise words of Warren Buffett “To invest successfully over a lifetime does not require a stratospheric I.Q., unusual business insight, or inside information. What is needed is a sound intellectual framework for making decisions, and the ability to keep emotions from corroding that framework”.
This article first appeared on PersonalFN here