Don't pick equity funds based on returns alone

Bungee jumping is an adventurous sport but not many have the courage to try or experience the jump. The visual of someone jumping down hundreds of feet is enough to scare the bravest of brave. Yet there are some who go for it for the sheer thrill that it provides and there are others who would prefer less daring sports to match with their thrill seeking capacity.

If a lesser thrill-seeking enthusiast is forced to do bungee jumping, it could turn into disaster. First timers who go prepared and experience the thrill may want to come for more and there are others who would prefer not to repeat the experience.

Investing is one such area where one needs to be aware of the nature of investment and the ups and downs that one may have to go through. Many first-time investors who entered the market in the last one year by observing only one year's performance would have certainly chosen a lot of small-cap and mid-cap equity schemes as this category did extremely well till a couple of months back. The prospect of earning higher returns seemed to be an easy job as the indices were moving up consistently. They would be ruing their decision on why they ever invested in the first place without understanding the risk involved. Some would have already decided to redeem their investments at a loss.

This situation is not new and keeps playing over and over. The abundant amount of information flow day in and day out from various forms of media, only adds to the confusion and very few investors try to make sense of the information flow or hire an advisor to seek guidance.

The ideal way to invest would be to first ascertain your financial goals and then decide which asset class would help achieve that goal based on time horizon, return expectation and risk profile. For example if your goal is to go on a foreign vacation in one year's time and you have kept aside funds for that purpose, then you need to invest those funds in a safe and fixed interest instrument such as fixed deposits or liquid funds. You cannot expect equity schemes to provide this stability and fixed returns in one year's time.

Similarly, if your retirement goal is nearly 10 or 15 years away, then even a lumpsum investment today in equity funds will be the best option. Over such a long time horizon, equities have known to deliver good returns. Another important factor is to select the right category or equity schemes depending on time horizon such as largecap, multicap, midcap, etc.

It is advisable for investors to first understand how different types of mutual funds work and set the right expectations before investing. Seek a good advisor's help if you don't have the time to do the research yourself. Avoid reading too much into daily market movements else you will not be able to remain invested peacefully even if your goal is quite some time away.

The writer is a Sebi-registered investment advisor and founder of Proficient Financial Planners