In 1973, Burton Gordon Malkiel, a Princeton economist, published the book “A Random Walk Down Wall Street.”
In the book, he makes an interesting observation:
A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.
In 1988, The Wall Street Journal conducted an experiment. Human stock pickers were only marginally able to meet the simulated monkey-throwing-darts.
Since then, numerous people have conducted tests to understand whether picking an investment product is art, science, or pure luck.
Some random portfolios made better returns compared to the index, others not so much. What gives?
This brings me to the question:
What’s the value in picking the right stock or mutual fund?
Selecting the right stock or mutual fund is only a small part of your investment strategy. The problem is, people spend 90% of their effort in picking investment products.
Majority of mutual fund investors in India are first-time investors. They are sold the idea that choosing a mutual fund is the most important step in the investment process.
The flaw with “the top mutual fund” approach
Search for “best mutual funds to invest in India,” “top mutual funds to invest in 2019”, or any such variations that might give you a list of mutual funds.
You’ll come across a Billion results! Across all these results will be 1,000s of different mutual fund schemes.
Surely, all these can’t be the “best,” can it? So how do you sort the wheat from the chaff?
Everyone has their definition of “best” – low volatility, high returns, high risk-adjusted returns, beat the index, return consistency, etc. Some businesses might even claim to have an A.I. driven approach to selecting the best funds.
The truth is, what might be best for someone else, might not necessarily be best for you.
Stop looking for the best mutual fund to invest
If you are the DIY kind, here’s what to do instead. If you’d rather not take on the headache, hire a financial advisor.
#1: Pay attention to your asset allocation
Your asset allocation probably matters more than product selection.
For the uninitiated, asset allocation tells you what % of your money is held across various asset classes (Equity, Debt, Real Estate, etc.)
Having the right allocation ensures that you gain from markets rising during a bull run. You also protect your capital when markets are volatile and investment value goes down.
The right asset allocation also helps you take the right amount of risk needed to reach your financial goals.
Based on your financial needs and market conditions, keep adjusting your asset allocation.
Note: Rule of thumb is to have equity allocation (%) = (110 – your age).
#2: Invest in an index fund
In the US, most investors invest in an index fund. However, in India, mutual fund investors typically invest in an active fund.
For the uninitiated, an index fund is a mutual fund that tracks a particular index like NIFTY or SENSEX. An active fund uses an index as a benchmark and tries to outperform the index.
Active funds are more prevalent in India because:
- There are no extensive indexes with a rich history like the S&P 500 in the US
- India is still not a fully matured market. Active mutual funds can still beat the index
Pro Tip: If you want to keep your equity investments simple, invest in a NIFTY 50 and a NIFTY NEXT 50 index fund.
With an index fund, you pay a much lower fee (0.15 to 1% compared to 1.5 – 2.5% of an active fund). There’s also a limited set of index funds which helps you avoid analysis-paralysis.
Warning: Don’t get swayed by the online comparison articles. If you take the right set of data to do an analysis, you can get it to say whatever you want.
You’ll see people who sell/recommend active funds claiming that active funds perform better; so will proponents of index funds.
#3: KISS (Keep It Simple Silly)
There are several flavors of mutual funds – Thematic, Diversified, Arbitrage, Hybrid, etc.
Understand what each fund does and pick one based on what’s best suited for you.
Don’t buy 50 mutual funds for the sake of diversification. Mutual funds, by their nature, are diversified. Holding just a few funds might be sufficient for you.
#4: Have clear goals
I have come across so many companies trying to sell mutual funds to people who do not really need them.
Yes, mutual fund as an investment product is excellent. However, for some people, it might not be ideal.
Make sure you have clearly defined goals with a specific timeframe and goal amount. This way, you’ll be able to figure out if a mutual fund investment is right for you.
#5: Set & achieve aggressive savings target
The essential part of investing is not selecting the right product or ensuring the correct asset allocation.
It’s simply living within your means and investing as much as possible, consistently. Every other strategy comes later.
Let compounding work its magic.
My personal investment plan
Before I tell you what I do, here’s a critical disclaimer. I am not a qualified investment advisor. What works for me might not work for you either.
- Equity – I invest in one actively managed mutual fund, one nifty-50 fund, and one nifty-next-50 fund
- Debt- I invest in EPF/PPF. This maxes out my 80C tax saving as well
- Emergency Fund / Liquidity – I invest in one liquid fund
- Real Estate – I currently rent and don’t plan to buy a home for the next few decades. My real estate exposure is limited to whatever I might inherit from my parents
- Gold – My wife has some gold. We are not a big fan of the yellow metal. So we have it safely locked away in a bank locker.
That’s it. Nothing too complicated!
So, what’s your plan?
Interested in knowing how you decide the allocation between active fund, N50 and NN50.
Nice article,,,, Simple yet impactful.
I have a query related to emergency fund tenure.
I understand that we need to have emergency fund enough to live routine life for at least 6 months. I also understand that Em-Fund should be liquid (earliest available when needed) and safest to protect capital.
However, we normally need to keep Em-Fund all the time, while liquid funds suggest that it should be chosen if your horizon is 3-6 or <3 months.
So that's where i get confused. Should I accept that for Em-fund, if you choose liquid fund, its horizon doesn't matter.
Interested to know your views.