Let us stir the long-running debate on whether to invest directly in stocks or go via the Mutual Fund route. Even though I invest in direct stocks to a good extent, I have consistently believed in mutual funds for various reasons. There are factual points and some are pure psychological points. The psychological viewpoints I will mention in the post have worked for me reasonably well, knowing what I am. Everyone is different, and psychology plays at different levels for everyone. So the limitations I have may not apply to you, and in that case, the decision strategy for that point could differ for you.
Frenetic reaction to market volatility
Dealing with the equities market is 90% emotion based, and 10% knowledge based. More investors fail due to a lack of control over their emotions. When a stock starts tanking all the technical and fundamental analysis flies out of the window! With mutual funds, I always see a diversified bucket and spread out risk even if it starts tanking. With individual stocks, I get a stronger urge of needing to “do something”, even though I may not end up acting upon it every time.
Running out of patience on individual stocks
It is a common pattern to see stocks go through a period of consolidation. Even though I take a long-term view at the beginning, any consolidation phase keeps poking me constantly as an opportunity loss. It severely tests my patience and pulls me into making portfolio reshuffling. With mutual funds, I’m generally more comfortable to wait and watch.
You won’t go wrong with Index funds
This has been my long-term safety net. If you name any broader diversified index, historical data has proved time and time again that they go up in the mid to long term. I never put stop losses on index funds, instead treat all dips as more buying opportunities. Index funds are the best form of passive investing from a diversification point of view. They play within a price band (if you look into price technicals), and breakout upwards. That doesn’t mean they never crash, but those historically have always been temporary movements. Index stock portfolio goes through recycling at intervals; weak-performing stocks get purged and stronger ones get inducted.
A recent news article showed that just five stocks in the Nifty 50 index contributed to 1000 point rally. For a normal investor picking those 5 stocks is never easy, but picking the index surely is.
Tapping into sectorial cycles
I buy sector mutual funds too. These are riskier than normal index or diversified equity funds, but they give excellent returns if you jump into that wave at the right time. You can say the same for any individual sector stock, but sector funds are still much more diversified. For example, if I am bullish on the Indian infrastructure growth and investment story in the coming years, I see an Infrastructure fund as a solid bet for a large chunk of investments, instead of analyzing every infrastructure stock.
Too much risk in mid-cap and small-cap stock picking
The higher volatility of mid-caps and small-caps keeps me more on the edge. Though I have my favorite stock pickings in this space, I do not have the risk appetite to over-invest in a single mid-cap or small-cap stock. With mutual funds though, I find the SIP route to give a lot more balanced risk-reward ratio. Mid-cap and small-cap stock volatility is also highly news-driven. It becomes difficult to analyze the long-term impact of that news. Hence, they play a lot more with emotions.
So how do I distribute my mutual fund portfolio?
- Large caps funds are the ones I avoid mostly. Historically, they have not outperformed index funds by any means. With lesser expense ratios, Index funds have always been a go-to for me. I do bulk investing in index funds at dips considering the long-term price movement of the index has always been upward.
- A good portion of the portfolio goes into mid-cap and small-cap funds. They provide excellent returns in the long term (> 5 years). SIP is the way to go with them. I do top-up SIPs on sharp dips too which has typically worked out well.
- International mutual funds take up another fraction of investment. I bet on the US market story, especially the tech stocks. These funds provide easy access to those growth stocks.
- I avoid balanced and hybrid funds. They are all very confusing to me. If I need to go for debt, I go for specific debt instruments and funds keeping an eye on the interest rate cycle.
- Commodity ETFs (Gold and Silver) take up one pie of the portfolio. They serve excellent balance to the equity price movements and outperform during big negative market sentiments.
Investment in mutual funds is not just about returns. They go well with my sentiment handling of overall equities movements. Diversification always remains a big factor. Certain individual stocks could skyrocket, say Nvidia! But setting that as a benchmark for your overall investment is unrealistic. I see a double-digit 12-18% CAGR as an achievable number that gives exceptional compounding to the portfolio.
As a point-in-time snapshot of my fund portfolio, here are roughly the CAGR each mutual fund category has given over mid to long term (~ 5-7 year duration). The sole intention is just to share the realism of fund performance and how risk and reward go hand in hand.
Index – 12-14%
Large & Mid cap – 20%
Mid cap – 21%
Small cap – 24%
International – 12%
Sector: Healthcare – 12%
Sector: Infrastructure – 25%
