Forget A Blissful Retirement If You Invest In Mid & Small Caps Now…

“Buy in a panic, exit (or sell) in a euphoria”, is the guru mantra of investing in equities.

But unfortunately, retail investors tend to do just the opposite. They buy during exuberant times, and sell when the market (S&P BSE Sensex or the CNX Nifty) is falling like nine pins. As a result, they often lose their hard-earned money.

Recently, a media report highlighted how retirees insist on investing in small and mid-cap schemes. Lured by the extraordinary returns projected, retirees are asking their advisors to shift their investment from debt and balanced funds to mid and small-cap funds. But, this can turn into a financial disaster for retirees.

So, what’s driving retired investors to these high-risk assets?

Firstly, the immensely low interest on variety of fixed income instrument: bank fixed deposit, NSC, KVP, and even PPF. Bond yields are around 6–7%. So, retired investors are clearly in search of higher returns.

Secondly, they are following the herd. A next-door neighbour or family member or friend invests in equity mutual funds — they hear them brag about bountiful gains made — and so they too crave to invest.

But the point they’re missing is, while equities offer potentially higher returns, the risk is proportionately higher too, particularly in the mid-and-small space. A fact is: most retirees aren’t equipped to deal with this level of risk.

If you’re a retiree, psychological traps and misconceptions may turn a blissful retirement into a nightmare.

Some interesting findings…

DALBAR, a US-based financial services market research firm, over the past 20 years, has measured the effects of investor decisions to buy, sell, and switch in and out of US mutual funds over short and long-term timeframes.

They find that the average investor earns less — in many cases, much less than the market.

They state that over the past 20 years, equity mutual fund investors have seldom managed to stay invested for more than 4 years. This short-term retention does not adhere to a prudent, long-term strategy, and is likely the result of short-term thinking and market timing. And here’s how the average equity-fund investors have fared vis-à-vis the S&P 500 as the benchmark…

Consistent Underperformance of Equity Fund Investors

(Source: DALBAR, PersonalFN Research)

Their analysis throws up some interesting insights. They find that mutual fund flows coincided with the market direction. This means that when the market moved up, equity fund inflows increased and vice-versa. But the above chart proves that timing the market, especially while investing in mutual funds can be futile-and even hazardous to your wealth and health.

Now while the average investor-return data is not readily available for India, here’s an interesting chart that throws light on investor behaviour…

Consistent Underperformance of Equity Fund Investors

(Source: AMFI, PersonalFN Research)

The chart above reveals that Indian investors have rushed in to invest in equity mutual funds when the market is on a bull run. This is clearly visible in the periods between 2003 and 2008, and then again post-2014.

However, the moment equity markets begin to struggle, as seen between 2009 and 2013, investors turn weary of investing in equity and begin to withdraw their investments.

So, will equity mutual funds suffer another exodus the moment markets correct? Well, only time will tell. However, based on the past trends of the market, it may be very likely.

Investors lack patience.

You see, it’s harmful for your financial health to invest based on the whims and fancies of the market.

(Source: AMFI, PersonalFN Research)

From the above chart, it can be concluded that on an average, only 38% of the equity assets are held for periods greater than two years. While the holding period is longer than that of non-equity funds, it is still less than the ideal holding period for equity assets. About 40% of the equity assets are held for less than a year.

Where is the Indian equity market headed?

PersonalFN believes an upswing in the market will pause, eventually. Valuations are looking expensive on a trail earning basis. There is a flush of liquidity from foreign investors, but markets would soon track routine events such as corporate earnings, industrial growth numbers, inflation data, RBI monetary policies, and so on. The market will support the high valuations only if corporate earnings and industrial growth are encouraging. Inflation and the RBI monetary policy should be conducive for this growth.

What should be your investment strategy?

PersonalFN is of the view that, before putting money in equities directly or through mutual funds, you should be sure that you don’t need that money for the next five years. You should not to get carried away by the current market rally that is getting stronger by the day.

More than getting your timing right, PersonalFN recommends, concentrating on the right asset allocation. Invest with a financial plan in place — that can enable you to accomplish your financial goals. Avoid making ad hoc investments or it could turn out to be detrimental to your financial health.

There are several benefits of investing as per your risk profile and personalised asset allocation. This knowledge is essential for you to succeed in achieving all your financial goals. You don’t need to go anywhere to gain this knowledge, you can get it right here sitting at your desk or in the comfort of your home.

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