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DIY investing – great access but beware the risks!

by Money Puzzle   ·  October 18, 2019   ·  

DIY investing – great access but beware the risks!

by Money Puzzle   ·  October 18, 2019   ·  

Photo by Valeria Boltneva from Pexels

Ever tried cutting your own hair? Its physically demanding and the result is unlikely to be what you desired when you began.

We are able to accept the physical impossibility of a task with an ease which often doesn’t extend to accepting our handicap when it comes to the cognitive grasp of a task. The ego perhaps doesn’t let us. But here’s the thing, if we can trust a hairdresser with how we look, then let’s accept that we may need some help with our investments too!

The advent of several digital platforms has made investing in financial securities literally available at our finger tips. A quick search with the word ‘invest’ in your mobile play store or app store will result in at least 20 options. Many will have a 4 to 5-star rating too. All you need to do is pick the one that suits you, download it, fill in the required personal details and begin. The in-person verification required for KYC gets done later.

Do-It-Yourself or DIY at its best. But how smart is it to DIY?

While the process is simple enough, the hard part really is in choosing the scheme which is best suited to you. Here is where you need to question your ability to filter through all the nuances to arrive at one or two schemes which are best suited for you.

What can go wrong…

Let’s assume that you have been doing all the right kind of reading and have figured out that equity mutual funds are an appropriate choice for long term wealth creation. The next step is to buy or invest in one. How will you do that yourself?

When you search for an equity fund in the app or website, there will be not one or two but many equity funds that show up on the list. Many of these searches list on the basis of 3-year past performance rather than one-year past performance, which is a good thing. However, it will still not help you.

Another quick search, this time for the best performing funds (today) will lead you to technology-oriented funds and US Opportunity funds. While it may be factually correct that these are the best performing equity funds at the moment, they are not suited for most first-time investors. Why?

Both these types of funds are thematic which means they invest in a particular segment of the market; technology-oriented stocks in the domestic market and stocks listed on US exchanges respectively. Any theme will be narrow in its scope of portfolio choices and also returns will move dramatically depending on whether the theme is doing well or not.

The potential volatility in such schemes can be too much for first time investors. What first time investors need is a more diversified portfolio of stocks, spread across sectors.

Moreover, before getting to overseas equity exposure, one has to first experience the domestic equity journey to understand the asset class better.

Go with the flavour or the month?

It has been reported that in September, PayTM Money which claims to be India’s largest online platform for mutual fund investing, saw most investors buying into small cap funds. Three of their top five equity schemes which saw maximum investment in September, belonged to the equity small cap category.

What do you really know about this category?

Here is the perception:

  1. Small cap stocks have the potential to emerge as leaders in their industry over the next decade.
  2. Owing to the above, small cap funds deliver higher returns than regular large cap funds

Nothing wrong with small cap funds, except that returns can be a lot more volatile. Which means the risk of under achieving your expected return even in the long run is higher than say a diversified equity fund or even a large cap fund.

At the moment small cap category returns in the 3- and 5-year period are seriously lagging large caps, so who knows why these were the most bought.

Perhaps, one feels that the worst is over and these funds will have a sky rocketing return period from here on! There isn’t just one metric that should be used to buy into a fund; it’s a combination of past performance, consistency, future expectations, portfolio structure, fund manager, market environment and so on.

More importantly, it’s about your return expectation and your individual risk capacity. Remember while your action to make that investment takes a few minutes, you have to hold on to it for several years.

No easy way out…

Be careful with thematic funds that do well in short periods, be careful with small cap funds which can be volatile, but then where should one invest? Only large cap diversified funds?

There is no one answer and no easy way out of this dilemma. Where you should invest, really depends on what you want to achieve in terms of return and your ability to absorb risk. You may invest in a large cap fund today, which fares badly over the next 6 months, but if you are not able to stomach the risk of losing capital early in the equity investment you will withdraw and never come back. There goes long term wealth creation.

When you are trying to figure it out yourself, there is a bigger risk of you picking a fund which may have gotten you excited with its recent return behaviour but in fact its long-term return trajectory differs greatly from what you expect. This could be on account of the market segment the fund invests in or on account of quality of the underlying portfolio. You will not be able to tell till you have already borne the risk and seen it play out.

How can one overcome risk?

  • Risk of making uninformed choices

The problem of plenty presents itself beautifully when you consider mutual funds investing on a DIY digital platform.

One way to reduce the risk of making uninformed choices is to get an advisor. You can still execute online, but at least you have some help from a professional in deciphering the various metrics towards choosing the scheme most appropriate for you.

There are online advisors too – robo advisors – which will help you narrow down fund selection depending on the goal you want to achieve. Whether robo or human, advisors can help you systematically add funds to your investment portfolio after considering your individual requirement and risk-taking ability.

  • Risk of poor fund performance

While consistency is a desirable trait in a mutual fund, every now and then funds which were so far consistent can change trajectory. It could be that the fund manager changes or it could be that the directive or objective of the fund is altered or even the asset manager may get bought over. Whatever the reason, it does happen.

To avoid too much damage from times when fund performance turns inconsistent, you need to have a diversified portfolio. Diversification is almost like having a balanced meal; you need a good mix of food types to get all your essential nutrients.

If you are investing in equity funds, pick 3-4 which suit your requirement. But make sure that the underlying scheme objective and hence, portfolios are suitably varied. Else you may end up with more of the same stocks than useful for optimum diversification. If you are parking money in liquid or short-term income funds, depending on the amount you have to invest, pick 1 or 2 different schemes.

Diversification will help safeguard you from unexpected and unsystematic failures in a particular scheme.

  • Risk of unreasonable expectations

There is no magic in equity investments. You may see that a fund has delivered 15% annualised return in a 3-year period. It’s unlikely that every time you check the 3-year return of that scheme it will show up as 15%. In some periods it could be negative as well.

Three things that you must remember

  • Higher return within the same category comes with higher risk. This is something you have to watch out for closely in case of debt funds.
  • Equity funds are meant to deliver inflation plus returns. In reality, returns from equity reflect the economic growth and corporate earnings growth in a particular business cycle. It’s unreasonable to expect high returns from equity assets at a time when economic growth is slowing and corporate earnings are under stress.
  • For most efficient returns from equity, you have to endure at least an entire business cycle which can be anywhere from 7-10-15 years.
  • In debt funds, chasing high return can also result in irrecoverable capital loss. Make sure you know why you are investing in a particular debt fund and don’t confuse high return with safety and stability.

Investing yourself is an experience that will last you longer than the time taken to execute a transaction. If you are looking for wealth creation, it’s an experience that ideally should last for at least a decade.

Don’t be afraid to ask for help. While digital execution gives you the access, it doesn’t always give you the most accurate result. Look for a combination of access and advice to make the most of your digital investment journey.

DIY, but with some help.

1 Comment

  1. […] you are a do it yourself type of person, then do your homework yourself too. Take the time to do the research behind these […]

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