Can you follow "one fund fits all" mantra for investing?
Following the herd is a very common phenomenon, be it education, jobs or even investing. But its negatives are most acutely felt when it comes to investing – where you stand to lose lakhs if not more!
Herd Mentality in Investing
To put it simply, herd investing means blindly copying what the crowd is doing, whether it’s about buying a consumer product or investing in mutual funds or stocks. With investments, it’s always tricky to know if your decision is correct. Only a few of us are actually born with the knack of choosing the right funds or stocks to invest in. For the rest of us, the options are clear – either study and research to decide, or simply invest in the fund everyone is investing in. And, most fall in this latter category, thus falling prey to the herd mentality and doing more harm than good to themselves.
Let’s elaborate. Suppose you don’t understand the stock market much but still invest at the behest of your peer or get swayed by noticing how everyone’s making money off it. Now, when the market dips, you will be quick to follow other investors and sell your stocks without really knowing or understanding why to do so. Alternatively, if you were investing in funds, due to a fall in the market, you may start pulling out your money. But in both the cases, you are taking a decision without really understanding the triggers and the consequences.
While herd investing will benefit you on occasions but in the long term, it won’t hold and might make you lose out on opportunities.
"I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful."
This Warren Buffett quote sums up herd investing beautifully!
How to Get Out of the Herd Investing Trap?
In order to invest on your own and not follow the crowd, you first need to understand what kind of any investor you are. Knowing your investor profile is the first step towards making informed decisions with respect to investments.
Your Time Horizon
It’s important to know how long you are willing to or have tohold on to your investments. Your investments’ time horizon can be deduced by the financial goals that you are saving for. For instance,if you are saving for buying a car or building down payment for a house, it will be seen as a short- to medium-term goal.Take a look at the table below:
Therefore, before you start investing, decide what you are investing for. It’s only then can you truly make your investments work for you.
Your Risk Tolerance
While all of us want to grow rich, not many of us are comfortable with fluctuations in our investments. Take for example, would you be willing to invest in a high-risk fund which has a 50:50 chance of tripling in value within 2 years? The flip side of this investment is that there is also a 50:50 chance of losing your investment entirely. To be able to decide on this requires careful evaluation of your current financial situation and knowing whether you can part with such a hefty sum in the future if things don’t go your way.
Note, irrespective of your investor profile, if you carefully allocate your investments across asset classes and fund types, your portfolio will be able to withstand market fluctuations
Types of Mutual Funds
Based on the above discussion, it’s important to know which mutual funds to invest in. As there are multitudes of funds, it’s critical to know if the one you have shortlisted meets your goals and risk tolerance.
Mutual Funds by Asset Class
Equity funds: These funds invest in companies stocks or shares. They are considered high-risk, high-return funds. They can be further classified as follows:
• Arbitrage funds: They generate returns by capitalizing on the price difference between current and derivatives markets.
• ELSS: These funds are ideal for tax-planning as they help save taxes under Section 80C of the Income Tax Act.
• Sector Funds: They invest in specific sectors and can, therefore, be very risky. To invest in these funds, it’s important that follow that particular sector and know when enter or exit those funds based on the economy’s shape.
Debt funds: These are low-risk, low-return funds as they invest in “safe” instruments, such as company debentures, government bonds, and others. The sub-categories of debt funds are as follows (but not limited to):
• Money market funds: These funds are seen as a safe investment as they invest in short-term fixed income securities, such as treasury bills, certificates of deposit, among others.
• Liquid funds: The duration of investment for these funds is up to 90 days. As a result, they are considered highly liquid funds and are meant for short or ultra-short duration.
• Fixed maturity plans: These funds are similar to fixed deposits, only better! They work well for investors that fall in higher tax brackets.
• Short-term and Ultra short-term funds: These funds invest in debt securities with the investment horizon ranging from a few months to a year (for ultra short-term funds) and from 1 to 3 years (for short-term funds).
• Gilt Funds: As these funds invest in government securities, they are vulnerable to changes in rates of interest and other economic factors. They are suitable for long-term investments.
Balanced funds: These funds invest in both equity and debt funds. They are ideal for investors who are risk-averse but want high returns.
To sum it all up, if you know what you are investing for, what duration, and how much volatility you can withstand, you’ll be able to figure out which fund to invest in as well. Find out what suits you and you will be able to benefit from wise investing.
