(This post first appeared on MoneyControl.com)
A question we get asked very often is, "Is this really a good time to invest in equity or equity mutual funds?"
The reasons are obvious. There is a feeling that equities haven't gone anywhere in the last few years and the stock market has been quite volatile. Interestingly, the same question is also asked when the markets have run up. At that time the fear is of investing at the top.
A good answer would be a quote attributed to the investor John Templeton, "The best time to invest is when you have the money." There is a lot of wisdom and science behind that simplistic quip. An investor who is investing for the long term should not concern himself with daily or weekly movements in stock prices or market benchmarks.
Our research of historical market data has shown that an investor who stays invested for about 7 years has a high probability (67%) of achieving a return greater than 15% and even higher probability (75%) of achieving a return greater than 12%. This analysiswas done on monthly Sensex values, so the return expectation is for an investor investing at any random point in the last 30 years and holding for 7 years.
However, for a three-year holding period that probability drops to 50%. So clearly Equity investing is not for the short term.
A decision to invest in equity must always be made with realistic expectations. Over a thirty-year period equity in India has delivered a 16% annualised return - multiplying an investment more than 100 times. This is the best performance amongst all investment options, beating Gold (17 times), FDs (18 times) and Silver (21 times). The point to note is that the number is 16% and not 50% or 100% per annum. And there were significant variations from that average in the journey.
The best way for retail investors to benefit from equity investing is to take the mutual fund route. Professionally managed and tightly regulated, mutual funds make equity markets accessible to the retail investor who cannot or does not have the time for stock selection and monitoring. This also comes at a very reasonable cost - probably the lowest cost for active management of money anywhere in the world. A significant number of funds also consistently outperform the market reflecting the skill and expertise of managers.
Mutual funds also practice excellent information transparency with full portfolio disclosures and prudent reporting guidelines. Add to that a very active financial press and online media, that provides in-depth analysis and tools for selection to investors.
Within mutual funds, we believe multi-cap diversified equity funds to be the best option. This is simply because such funds have complete flexibility on making sector and stock choices. When an investor picks a sector fund or thematic fund, he is stepping into the realm of active management. He has to track the prospects of that sector and make entry and exit decisions. A retail investor, or even their financial advisor may not always be best equipped for making this decision. Fund managers are much better placed to do so with their knowledge, experience and the research resources at their disposal. Not all mutual funds are, however, equally successful in delivering superior returns to their investors. What the investor needs to do is choose the fund manager with care.
We don't think equity is appropriate for all investors and all situations and investors must be aware of that. Investors should choose the right investment option that matches their investment duration and goals. So if you are investing with a short time horizon – you should go for less volatile options like debt funds, balanced funds or FDs. Similarly, if your goal is very near term and completely non-negotiable – you should choose fixed return options.
At the same time, each such decision must be taken with full knowledge of the changed return expectations. An asset allocation between different investment classes provides a blended return, which may be less volatile but is also lower than what equity alone provides. This means that you must be prepared to invest more to achieve the same target amount.
Equity investments are a great long-term option for investors but you must invest with realistic expectations, ignore daily and weekly movements and avoid timing the market. Diversified equity mutual funds provide the best option for retail investors to invest in equity. Investors must consider the duration of their goals before choosing between equity and debt.