If you are one of those investors who rely too much on past performance for making an investment decision, you need to rethink strategy.
Although this is an important aspect in decision-making, relying too much on it can backfire. Even while considering it, the focus has to be on long-term performance.
Mutual funds offer a variety of equity funds, i.e. multi-, large- and mid-cap, sector, thematic and those which follow an aggressive investment strategy such as opportunity and value funds.
As we know, different segments of the stock markets behave variously over different periods of time.
Therefore, at times, you might find some aggressive funds like mid-cap, sector or thematic dominating the list of the top-performing.
Investing in these, at that time, would make your portfolio too aggressive.
As a result, you could end up taking more risk than you are financially and/or psychologically capable of.
Similarly, a performance analysis of equity and equity-oriented funds during the periods of market downturns would project a disappointing picture.
We have been witnessing a similar situation over the last couple of years.
If you were to consider the performance during these years, you would find it difficult to make any significant allocation to equities now.
Hence, you must look beyond short-term performance to make a rational choice.
Considering factors like the need to maintain your asset allocation, the potential of equities to beat inflation as well as to out-perform other asset classes in the long run would help you make a sound investment decision.
While one cannot say with certainty that stock markets won't fall from here, waiting to invest at the bottom can be a futile exercise.
The key is to follow a strategy that combines the benefits of investing a lump sum with the systematic profits from averaging.
Another factor that requires attention is time diversification i.e. remaining invested over different market cycles.
It helps in mitigating the risks you might encounter while entering or exiting a particular investment or category at a bad time in the economic cycle.
Remember, longer time periods smooth these fluctuations.
In fact, time diversification is also important for the debt portfolio.
You need to have a personal yardstick, which you may better with investment in a debt or debt-oriented fund.
This may, for example, be the returns you have been getting from some of the traditional investment options like deposits, bonds and small savings schemes.
To achieve this, the key is to manage credit and duration risk.
While investing in ultra short-term and short-term debt funds and fixed maturity plans is fairly straight forward, investing in income funds, especially those that follow an active duration management strategy, can be tricky.
That's because interest rates and bond prices have an inverse relationship i.e. when one goes up, the other goes down.
Considering the yields have risen beyond 8.80 per cent, and as we approach the end of the rate increase cycle, income funds would benefit when rates begin to ease.
Hence, it may be a good idea to invest in these with a time horizon of one to two years after, the impending rate increase by the Reserve Bank of India.
No doubt, a strategy like this would suit you only if you don't mind taking some risk to get higher returns. Here, too, if you consider the last one year performance of income funds, it may not sound like a great idea.
As is evident, looking ahead can make a success of long-term investment decisions.
The writer is the CEO of Wiseinvest Advisors. Views expressed are his own.
