Steps to make money in equity mutual funds

As you can see, the quantum of returns increases as time goes by and that’s only to be expected since – as any financial advisor will tell you – the longer you hold a mutual fund, the higher your chances of getting better returns. Aside: if you’re wondering why 3/7yr returns are higher than 5/10yr returns, it’s because the past couple of years have been tough on the equity markets. These things happen. Focus on the fact that for a 3yr+ plus holding, you’re still making reasonably good returns. 

Obviously, not all funds are born equal. Indeed, some give far better returns and some fare badly. Choosing a mutual fund should, therefore, be an informed and educated decision. This is not tough; a financial advisor should be able to help you out with this decision making process, after taking into account your risk-return profile and your objectives. However, what’s tough is waiting it out. And the news on this front is depressing. Consider the following:

1. 80% investors buy equity when it is expensive: IDFC Mutual Fund recently carried a provocative ad with the headline “Want to lose money in the market? Here’s how”. Furor on social media apart, the ad made a valid point – “80% investors buy equity when it is expensive”. Hence, what chance will they have of making returns? Not much. Because, as IDFC MF’s CEO, Kalpen Parekh tweeted, “So at 20 times market PE history has shown market reruns over next 3 / 5 years to be less than FD! Hence don't invest for 3 but 10 years” Ironically enough, the CEFPI/Nifty chart above proves Mr. Parekh wrong (3yr returns were higher than 10yr returns – but that’s for a specific time period ended 31st Dec 2015). Still, the broader point being made was valid; namely, when you buy expensive (not “high”, but expensive, which is a function of valuations), your chances of making profits are lower. Mr. Parekh backed that up with data that – arguably for the first time from a mutual fund – showed that 80% of flows into equity mutual fund schemes came at 20x price-to-earnings. This is popularly known as “herd mentality”. Interest in stocks rises only as stock prices rise. So, lesson no. 1: remember what Warren Buffett said: “be fearful when others are greedy and greedy when others are fearful”. 

2. Too few stay invested for the long-term: While current data isn’t available, a March 2015 article in Business Standard noted that half of all MF investors held on for less than two years. Data for how many investors hold on for 10year periods isn’t currently available. However, take HDFC Equity Fund, one of India’s largest and oldest equity mutual fund schemes. Only 5,000 investors have stayed with the fund through these 20years [Source: HDFC Fund]. These lucky 5,000 investors have got 19% CAGR for 20years. Think about that for a while: Rs10 in 1994 is equal to Rs407 today. That’s if, and only if, you stayed invested for 20years.  So, lesson no. 2: after choosing your mutual fund stay invested for at least 5years, if not 10years. There is no guarantee you will make massive amounts of money. But you will, at the very least, increase your chances of making a profit.

Indeed, if retail investors aspire to make risk-free, guaranteed returns in the short-term, they are better off in a fixed deposit. So, the key to making money through equity mutual funds is to get in when its down and stay in for long.