BUILDING A PORTFOLIO

Most retail investors make equity investments with an intention to earn healthy returns that can offset inflation. But do we keep this objective in mind while constructing our portfolio of funds? Here, we outline some of the common errors made by mutual fund investors while constructing their portfolios and also discuss the alternatives:

Fancy for new funds: Many investors build their entire portfolio by investing in New Fund Offers (NFOs) as and when they crop up. But if a fund is not based on a theme or idea that is unique, avoid investing in the NFO. Fund houses may offer new products with fancy names to catch your attention, but they may be nothing more than old wine in a new bottle.

Theme funds are often not very different from diversified ones. Remember, currently there are 246 diversified schemes on offer, with to help you decide whether or not to invest in these funds.

With entry loads abolished, there will be fewer NFOs and your distributors will also not push sales as they have less incentive to market the same. All the more reason to look for, and invest in, funds with a track record.

Low NAVs: Choosing an equity fund because its NAV is lower is a mistake. Keep in mind that it is the NAV appreciation that determines your return. The starting NAV has no bearing on this appreciation.

For an investment of Rs 1 lakh you can buy 10,000 units of a fund whose NAV is Rs 10. After two years, if the NAV appreciates to Rs 14 your compounded annualised return is 18.3 per cent.

Now, for the same amount you may be able to buy only 2,000 units of a fund whose NAV is Rs 50. If the fund sees its NAV grow to Rs 75 at the end of two years, the compounded annual return works out 22.5 per cent.

A high NAV shows that a fund has managed good performance over the years.

Don’t buy something just because it’s cheaper.

Invested because I got a lump-sum: This is very common among younger investors. Your decision to deploy money in stocks has to factor in the market levels and valuations at the time of investing.

Choosing to invest a huge sum at one go in the stock markets exposes you to the risk of bad timing, if markets happen to be overheated at that time.

We are not talking about timing the market. However, phasing out investments over a period of time will ensure that you don’t take the plunge at particular Sensex level. Choosing your funds carefully is also important.

If you had invested a lump sum on January 8, 2008 in top-performing large-cap funds such HDFC Top 200 and DSP BlackRock Top 100, your capital could now have eroded by 12 per cent and 20 per cent respectively.

But had you invested in top-performing midcap funds such as Birla Sun Life Mid cap and Sundaram BNP Paribas Midcap, your portfolio would have lost 30 per cent. Had you invested in average performers, the losses could have been still steeper.

If you are investing after a strong rally, spread your investment over a period of time, based on your risk appetite.

Investing fresh money without taking account of your current portfolio: This will create overlaps in your investments. Take stock of the funds and investments you already own while considering a new investment.

Discuss with your advisor and find out whether the schemes are in line with your risk profile. Don’t add too many schemes just for diversification. It is better to restrict the number of schemes too, for easier monitoring. Consider allocating a portion of your portfolio to passive exchange traded funds (ETFs). ETFs mirror market returns as they invest in the same proportion as of the benchmark.

Don’t a dd too many schemes to your portfolio just for diversification.

Timing your systematic investment plan (SIP): The usual mistake many of us make is that we start SIPs when the market has already risen and stop once the market starts to correct.

By doing this, we are actually buying at higher NAV and stopping when it is low. That means that the average entry NAV will remain relatively high, reducing returns when the market corrects from a peak.

For instance, if you had started an SIP in HDFC Top 200 from January 2008 and stopped after 12 instalments, your current return will be minus 49 per cent. But had you continued the SIP even during the market correction, your return today would be plus 38 per cent.

Don’t stop your SIP when the market hits new lows.