What Should New Investors in Equity Mutual Funds Do As Market Witnesses Sell-off

June 16, 2022 Mutual Fund

Investors in equity mutual funds made huge profits within a short span of time as the equity market recovered sharply from the lows of March 2020. However, most new investors in equity mutual funds who recently started their investment journey are currently staring at losses.

Returns on all equity mutual fund sub-categories have turned negative as many stocks, especially those in the mid-cap and small-cap segments, are down sharply from their record highs of October 2021.

This can be attributed to various factors such as persistent selling by foreign investors, the Russia-Ukraine conflict that has caused inflation to spiral globally, COVID-19-induced lockdown in China, a weak Rupee, and rate hikes by global central banks that has squeezed excess liquidity from the market.

Notably, the US stocks entered a bear phase on June 13, 2022, as the S&P 500 index plunged over 20% from its peak. In India too, various key indices are down by around 15-18% from their respective record highs, though they are not officially in the bear territory yet.

Table 1: Equity mutual fund returns turned negative amid sharp market volatility

Past performance is not an indicator of future returns
Returns are absolute. Data as of June 13, 2022
Direct plan – Growth option considered
(Source: ACE MF)  

If you are a new investor in equity mutual funds who has not witnessed many market phases, it is likely that you are perturbed about the recent losses.

So what should new investors in equity mutual funds do?

If you have been reading our articles, you will know that we anticipated the equity markets to remain highly volatile throughout the current calendar year and had advised our readers to be cautious about their mutual fund investments. Therefore, don’t expect equity mutual funds to generate extraordinary returns as they did between 2020 and 2021.

However, this does not mean that your investment in equity mutual funds will not reward you. Remember that market corrections offer fund managers of equity mutual funds an opportunity to pick quality, high-potential stocks at an attractive valuation. This, in turn, can reward you, the investor, handsomely over the long run, provided you continue with your investment.

The first thing to do is ask yourself why are you investing? If you are investing to fulfil a financial goal that is at least 5 years away, then there is no need to worry about the recent downtrend in equity mutual funds. The market is bound to recover sooner or later, and so will the returns on your equity mutual fund investment. But do note that markets are highly unpredictable, they may not always be quick to recover as they did in 2020. As a new investor, it is important to understand that the returns can even turn negative in certain years. Therefore, invest in equity mutual funds only if you have a long-term investment horizon.

As you can see in the table below, various sub-categories of equity mutual funds have generated attractive returns over the longer time frames of 3 years and above.

Table 2: Equity mutual funds offer attractive returns over the long run

Past performance is not an indicator of future returns
Data as of June 13, 2022
Direct plan – Growth option considered
(Source: ACE MF)  

It is also important that you select the most suitable equity mutual funds depending on your risk profile, investment horizon, and financial goals. If investments are made as per your needs, you are less likely to redeem or stop your investment whenever there are uncertainties in the market.

Conservative investors looking to earn steady returns at lower risk and volatility should stick to Large-cap Mutual Funds. If you are willing to take a slightly higher risk, you can consider Flexi-cap Funds, Multi-cap Funds, or Large & Midcap Funds. These categories follow a multi-cap approach to offer investors the benefit of diversification. Invest in Mid-cap Funds and Small-cap Funds only if you have a very high-risk profile as they are prone to sharp swings. You would be better off avoiding Sector/Thematic Funds as they can expose your portfolio to concentration risk.

As mentioned earlier, it is difficult to predict the movement of the market, one cannot if the indices have bottomed out or will there be more corrections. Therefore, investing in equity mutual funds through the lump sum mode can be risky.

In such a situation, opt for the Systematic Investment Plan (SIP) mode of investment that will help you mitigate the market risk by staggering your investment over a period.

If the market volatility continues, which is likely, or if it corrects further from the present level, the inbuilt rupee-cost averaging feature of SIPs would take care of the intermittent volatility; more units of equity mutual funds will be added on during the corrective phase of the equity market, and when it begins to ascend again, this strategy will compound your wealth.

That said, if you have an investible surplus, you can use any sharp correction as an opportunity to boost your equity mutual fund investment through the lump sum mode.

What is SIP (Systematic Investment Plan)? The 5 Benefits of Starting An SIP!

If you started investing in equity mutual funds buoyed by the meteoric rise seen between 2020-21, it is important that you set realistic returns expectation as such swift rallies occur very rarely. You can expect your equity mutual funds to generate compounded annualised returns of 10-12% over the long run, which is much better than the returns offered by most other traditional investment avenues.

This article first appeared on PersonalFN here