Benefiting from basics

The most successful strategies of investing in mutual funds are surprisingly also very simple. Here are some of the time-tested thumb rules to keep in mind.

Print Edition: May 29, 2008

How SIPs can reduce average cost

Oct 200723.855,000209.64
Nov 200724.725,000202.27
Dec 200726.525,000188.54
Jan 200824.645,000202.92
Feb 200820.515,000243.78
Mar 200820.805,000240.38
Total 30,0001,287.54
• Investing lumpsum in Oct 2007 would have got 1,257.86 units
• Despite buying at higher rates in November and December, SIPs reduced average unit price to Rs 23.30; price in October was Rs 23.85
• Investor benefited from lower prices from January to March

 Rebalancing your portfolio

1. You begin with 25% of your portfolio invested in equity funds and 75% in debt options

2. Markets rise, pushing equity portion to 40%. Sell equity funds to revert to original ratio

3. If rebalancing is not carried out, equity portion may rise to 50%, increasing portfolio’s risk You begin with 25% of your portfolio invested in equity funds and 75% in debt options

If we asked you why exactly you have units of whatever mutual fund you’re invested in, would you be able to answer? Chances are that you would have bought that fund because your friend or spouse or parent or colleague recommended it. You can very rightly say that’s why you are invested in a mutual fund and not directly in the markets. But blindly believing someone else is not a great idea—after all it’s your money and your financial goals that you’re investing for. We’ve already shown you how and why you should know something about the technical aspects of mutual funds—how and what the commonly used ratios are. Here’s where we look at how you can invest smartly through funds by following some time-tested strategies. You might already be doing some of this—now you would know the logic behind it.

Advantage SIP
Based on the concept of rupee cost averaging, a systematic investment plan or SIP offers you the option of managing investments on a periodic basis. SIPs allow you to invest a fixed amount in a scheme at set intervals, and derive the benefit of fluctuating share prices and NAVs. So, when the share price drops, you get more units and when the price rises, you get less. Finally, if the NAV is high, your entire investment is valued at the existing higher level, while the cost averages out (see table).

The biggest advantage of an SIP is that you invest fixed sums regularly over a long period, inculcating disciplined savings. With multiple market cycles taken into account, the price averaging of fund units helps you add more fund units over the long term and gain from the proven benefits of disciplined longterm investing.

Allocate assets

Any disciplined investment strategy calls for asset allocation, which is, in turn, based on a proven three-step process—allocate, diversify, rebalance. One without the other is an incomplete exercise. It’s a given that higher returns come with higher risk. You will naturally move towards that asset class that offers you the amount of risk you think you can take. But to ensure that your portfolio does not suffer too much in case of a downturn that affects one specific asset class, it pays to invest across classes depending on your age and risk appetite.


So, if you’re prepared to take a lot of risk, you might have a portfolio that’s overweight on equity funds. If you’re risk averse, however, you might go for capital protection funds. The trick is to spread the risk, so that if returns from one asset category fall, you will be in a position to counter your losses with better returns from another.

By including asset categories with investment returns that move up and down under different market conditions in your portfolio, you can protect against massive losses. Historically, the returns of equity and debt have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another to have average or poor returns. But asset allocation is just the start; for effective gains from asset allocation you need to diversify the portfolio and rebalance it occasionally.

Why rebalance
Although most investors have begun to understand the advantages of asset allocation and even diversification, rebalancing is something that most of them ignore. Determining an effective rebalancing strategy is a function of the mutual fund portfolio’s assets: their expected returns, their volatility, and their returns. The idea of rebalancing is to get all the asset classes back to their original allocation percentages, or any changed values that you are comfortable with. During rising markets, most investors would be tempted to add more to equities, rather than book gradual profits, leading to an asset allocation mismatch, which is most painful if markets correct suddenly (as was the case in January this year).

It is here that asset rebalancing helps you avoid portfolio value fluctuations. It ensures long-term growth by forcing you to book profits when markets go up and shifting them to safer debt instruments. It also brings a greater sense of discipline for an investor and provides a much-needed guideline to resist temptation in rising markets.

Remember, asset rebalancing is not a daily exercise, but it is important to understand when to rebalance a mutual fund portfolio. Experts suggest asset rebalancing every time there is a 5% variation across the asset classes. Another way to effect rebalance is to review the portfolio value once or twice a year depending on your risk profile. What you need to know is that rebalancing is a very important exercise that can help ensure that your investments are not exposed to undue risks and are sufficient to meet your goals.

Your diversification options

Across asset classes: Depending on your risk profile and needs, assets spanning classes—from equities to fixed income instruments, and gold to possibly real estate— should find place in the portfolio

Across investment avenues: Within each category, it pays to be diversified across various investment avenues. For instance, an equity diversified portfolio can comprise sector funds and quant funds

Across time horizons: As a rule of thumb, equity is for the long term and liquid funds for short term. The fund category should typically be in line with your financial goal

Across fund houses: If there are two identical funds in terms of investment objective, the fund house and the fund manager’s philosophy will make a key difference to returns. Ensure that you spread your investments across various asset management companies

Across countries: With the option to invest globally now a reality, look for opportunities in other markets and currencies to hedge your investments

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