Now that the markets seem to be on steroids all our MF portfolios, whether created through the SIP route or otherwise, will have done very well. In good times one will not like to hear about potential risks and downsides, yet this is really the time when the damage to the portfolio can be most significant. I thought it will be a good idea to outline what are the real risks in building and maintaining a MF portfolio . Understanding these risks will help us to figure out ways in which we can mitigate them.
The first and commonest risk is investors not putting in enough money to build up the MF portfolio. Let us see why this happens and what can be done about it.
- Investors do not understand the present cost of the goal and the associated inflation prevalent for that category. You need to find out some hard data and then apply the most logical inflation figure. Do not worry if the amount seems fantastic, it is better to be prepared. If you do not need it at the time of goal, use it for other things.
- Investors starting early set up a lower investment amount monthly and do not necessarily change it with increasing income. Do remember that it is always better to invest more than to invest less. Use a calculator that lets you input your initial amount as well as an annual percentage increase to check where you are reaching.
- As many investors have only a lesser amount to invest when they get started, they assume optimistic returns to reach the goals. Equity is the best investment avenue for the long term but do make sure that you are not thinking of 15 % returns and above. My suggestion will be to look at 12 % returns, if you do better it’s a bonus.
The second risk has to do with the mode of investment. Most investors end up doing a monthly SIP on a fixed date, without understanding that it is a completely wrong way to buy equity. I have explained this quite thoroughly in several posts in my blog. People who are interested can read the same to get the right way in which they can invest in MF units.
The third risk is in not understanding how an annual review is absolutely important to ensure that you are holding the right MF. Do not go by reputation of the fund or fund manager, performance of the fund has to be the only criteria. There are several choices available to you and no real need to be married to a fund. A corollary to this risk is not to be satisfied by the return you had estimated for your goals. Sure, you may be able to meet your goals with a return of 12 %, but if many funds are doing much better then there is really no point in sticking to your fund.
The fourth risk is in not understanding the impact of a market crash on your portfolio. Let me give a personal example here. By end 2007 my stock portfolio had reached a value that I was expecting only by 2010. This gave me the feeling that I would be able to achieve my state of financial independence a lot earlier than the plan of 2012. The market crash of 2008, nearly halved my portfolio value and I had to change my plans to some extent. At that time almost all of my investment apart from PPF was in equity. You need to follow an asset allocation appropriate to your context so that all eggs are not in the fragile equity basket.Remember that whatever your acquisition price, your entire portfolio in equity is subject to the vagaries of the markets.
The final risk is redeeming equity at the wrong time in order to meet the goals. All of us know that we should not do this, but if your goal is at hand and you do not have alternate sources of money you may have no other option. A way out of this is to go with the 3 portfolio model I have suggested in my blog. Read the posts in order to get a better understanding as to how it can be implemented.
MF is a great investment vehicle and it will work greatly for you at most times, as long as you understand the risks involved in it and handle these in an appropriate manner.