As mutual funds primarily invest in financial instruments listed in markets, they are prone to the market risk of their portfolio constituents. The key to successful investment in mutual funds is not the elimination of market risk itself, but to manage it through judicious portfolio selection and rebalancing as per your risk appetite.
Here are 5 crucial strategies for retail investors to manage their portfolio risk:
Select funds basis your risk appetite
Your risk appetite primarily depends on your income stability, liquidity and time horizon of crucial financial goals. For instance, investors having long-term financial goals can choose equity mutual funds, as equities have the potential to beat returns of fixed income products by a wide margin over the long term. While equities can be very volatile in the short term, a longer investment horizon allows equity investments more time to recover from the losses caused by market volatility.
Similarly, investors witnessing income uncertainty may have to park higher amount in debt funds in order to preserve their capital and liquidity to face periods of income and cash flow disruptions.
As various mutual fund categories contain different amount of risk appetite, make sure you take your risk appetite into consideration when selecting funds.
Opt for the SIP route for regular investment
SIP allows mutual fund investors to invest a predetermined amount automatically from their bank account at a pre-set date for buying units in the chosen mutual fund scheme. As investments through SIPs are spread over a period of time, the investment cost gets averaged during market dips and corrections.
To make the most of the entire investment cycle, equity fund investors should try to continue with their SIPs for at least 5-7 years. Also, given that SIP installments are deducted automatically from your source account, it helps in instilling financial discipline and eliminates the need for market timing.
Avoid investing in NFOs due to lower NAVs
New Fund Offers (NFOs) are first-time subscription offers of new mutual funds offered to the public at a face value of Rs 10. Many distributors try to upsell NFOs citing their lower NAVs. Instead of considering the lower offer price as the basis for investing in NFOs, investors should consider the past record of other funds managed by the NFO’s fund manager and the concerned fund house.
Opt for an NFO only if it matches your risk appetite and financial goals. If not, then continue with your existing mutual fund schemes having an excellent track record of beating its peer funds and benchmark indices.
As far as investing in NFOs of sector or thematic funds is concerned, only those having a higher risk appetite and the ability to closely track the underlying sector or theme should opt for it.
Diversify your mutual fund portfolio
Fresh retail investors usually invest their entire investible surplus in 1-2 mutual funds, which had delivered good returns in the near past. However, note that doing so concentrates the market risk in only one or two fund management teams. If the chosen funds perform poorly owing to the investment strategies of the fund managers or various market-related factors, the whole investment may underperform for an extended period. Thus, investors must diversify their investments across various fund houses to lower their concentration risk. If any of the funds underperform, then the other funds may be able to generate sufficient returns to compensate for the losses.
Periodically review the investment portfolio
A periodic review of the performance of your mutual fund investments will help identify underperforming funds and correct any deviations from the original asset mix set for the investment portfolio. Note that fund management styles and various market factors can lead excellent performing funds of the past to underperform for a longer time period. Thus, compare the performance of funds with their peer funds and benchmark indices every 3 months. Redeem the ones that have been constantly underperforming their benchmark and peers over the past 3 years.
Sahil Arora is Senior Director at Paisabazaar.com. The views expressed are personal