Many investors are complaining and worrying about their equity mutual fund investment whose have been investing, especially past the last 2 years, as their portfolio might be giving negative returns past a few months. Actually, they have been seen consistently positive returns in 2017 and early 2018 while good earnings of the year; this reason is enough to make, now disappointed them. It has been observed that most of novice investors tend to forget the fundamental rule of investing in equities and should remember always that stock market does not move in one direction, it remains inherent to be volatile, ups and downs and has to be gone through every cycles. Theses cycles must be influenced by several factors whether economic, political, global or investor expectations etc. Currently the market is in doldrums cycle and it is nothing new for it, it has been likely remain several times into the past and will remain be repeated over the next decades. Though for new investors this prolonged fall may be new and scar, they need to be patient, have faith on their investments and stay in course of every cycle irrespective of any negative or positive factors. It is, hence only formula to generate positive returns and create wealth creation in the long run, nothing else. Equities are meant for long term only.
Don’t focus on 0-3 years returns
In early 2018, the Nifty Midcap 100 has been lost 19% since January 2018 and the BSE Smallcap has been lost 26% due to overstretched valuations. Similarly, large-cap funds also fared poorly over the past 1 and 3 years. Since this is not the first time these segments have slipped so steeply, the years since 2014 also saw very brief corrective phases of a 2-3 months in the midcap and smallcap space from which recovery was swift and sharp. While considering rolling returns of different holding periods since 2007, there were instances of markets delivering losses even on a 4 and 5-year period. Only holding 6 years and above saw nil occurrences of losses. Similarly, we can currently see how divergent the returns are.
But seasoned investors tend to forget history of previous cycles of the market over the time and started to blame the current turmoil. Remember, 2017 was a year where everyone wanted to invest in midcaps for their portfolio to get higher returns at any risk. And as the next year they saw the scenario reverse, midcaps became obsolete and they go back and forth with their choices as they see returns swing. This can significantly impact the eventual returns you get from your portfolio. For example, if you had entered in 2017 looking solely at past returns and exited in panic in 2018 when you saw the returns falling, you would have booked permanent losses. Whenever you are looking for funds to invest and look at the performance screen of a fund, the 1-year returns is the number that registers and also influences decision. Being influenced by 0-3-year return can cost you a lot if that is all you look at. This is the reason why we regard mid-caps as risky and ask investors to have at least a 5-7 year period in mind while investing in them.
Evaluation of performing funds
Funds have to be evaluated based on multiple criteria including long term returns, volatility, ability to contain downsides and so on. This does not necessarily mean that funds with high 1-year return may not perform well. But that is not the only measure to see if a fund is good enough to stay invested in the future. While having a higher risk appetite when investing in equity, you need to be able to see the fall in your returns and not worry into exiting. By redeeming or switching out immediately after your funds have dropped is similar to buying at a high and selling at a low. You are, actually converting your notional loss into permanent loss. You should restrict allocations to midcap and smallcap funds upto maximum 10% of your overall portfolio, no matter how attractive their 1-year or 3-year returns may look. Since these tend to fall more steeply, avoiding excessive exposure will protect your portfolio from corrections. While the market goes through ups and downs, if you stay with the market long enough you will generate higher and inflation-beating returns.
Here is opportunity for you
Though the 1-year return at the end of 2018 was -11.39%, 5-year return for the same period was 13.29% annualised. For someone who invested 5 years back, this fall didn’t do much damage. In fact, someone running SIPs during the fall will benefit immensely when the midcaps take an upward turn again. But wait, there’s more. These downturns are not something to just sit idle and wait out. What is essentially happening at this phase is that the market and your funds are trading at a discount to what it was one year ago. Which means that if you invest today, you will get a higher number of units at a lower cost. Once the market bounce back, your notional losses could get immediate recover and get turn into profit.
This is why we emphasise on the importance of investing through SIP. If you invest regularly, when such falls occur, you buy more units at a lower NAV, thereby bringing down your average cost. This means that when the markets eventually recover, your investments made during the downturn will earn you higher profits.
So to answer the questions raised earlier, your mutual funds have disappointed you because that’s the nature of equity markets. Sometimes it disappoints in the short term. As for what you should do, you should keep investing and wait it out. Given sufficient times, you will once again see the positive returns which had lured you into investing in these funds.
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