Pratik Oswal Head - Passive Funds Business, Motilal Oswal AMC
In the investment management industry, the advice offered by financial advisors often revolves around well-established principles. However, there is a layer of wisdom less commonly discussed yet very important, specially for those new to the investment arena. This article sheds light on six critical pieces of advice that, while often unspoken, are crucial for developing a sound investment strategy.
Merit of Inaction
Investors in India often have expectations whereby they expect their advisor to sell their investments before a fall and invest big before a bull run. These expectations lead to advisors almost never saying the words - “Don’t do anything.” because this advice can never justify the fees. In reality, however, an advisor who makes this statement should be paid twice the fees.
In a domain where activity is often equated with progress, the strategic value of inaction is frequently overlooked. Markets are impossible to time. Even timing successfully leads to less wealth creation than just holding on in good and bad times. True wealth creation is a slow and passive process.
The peril of FOMO
The Fear of Missing Out (FOMO) can lead to hasty and misaligned investment decisions. Investors are frequently tempted to chase high-performing markets or sectors, driven by a fear of missing out on returns. FOMO is a dangerous trend and leads to most investors damaging their long-term wealth by buying trending investments. If something is popular - staying away is the best advice. An advisor finds it easy to sell trending investments - hence, investors should be careful before buying anything trending.
Aligning investments with one’s individual risk profile and long-term strategy is best. Effective investing requires disciplined adherence to a strategic plan, not impulsive reactions to market trends.
The efficacy of Index Funds
Index funds offer a practical and efficient investment solution for all investor types. Today, investors ranging from sophisticated family offices to retail investors have all adopted index funds well.
These funds track market indices, providing a diversified and cost-effective approach to equity investment. Over the long run - the low-cost nature of index funds can lead to excellent outcomes. In addition - investors need not worry about poor investment choices as index funds track the general market.
Don’t rely solely on past performance
Reliance on historical market performance as a guide for future investments is a common misconception. Rarely do mutual funds with exceptional track records repeat the same over the next few years. Hence, apart from performance, investors should look at other information before buying mutual funds.
It is essential to recognise that past success is not a reliable indicator of future returns. Investors should be cautious of increasing risk exposure based on historical market uptrends and instead focus on aligning their portfolios with their personal investment goals and risk tolerance.
Optimal diversification in MF investments
There is a popular saying - “the more you have, the more you have to worry about.” While diversification is a key principle in risk management, accumulating too many mutual funds can lead to an overtly complex portfolio. An optimal portfolio typically comprises 6-7 well-chosen mutual funds, providing adequate diversification without unnecessary complications. This approach ensures efficient portfolio management and minimises the risk of overlapping assets.
Spreading across different asset classes
Diversification extends beyond the number of mutual funds in a portfolio; it also encompasses the distribution of investments across various asset classes. Spreading investments across different asset classes – such as equities, international equity, bonds, real estate, and commodities – helps reduce risk and enhances the potential for balanced growth. Each asset class behaves differently under market conditions, and a diversified portfolio can better withstand economic fluctuations, ensuring more stable returns over the long term.
Understanding these six key pieces of unspoken financial advice is important for a well-rounded and effective investment strategy. From practising strategic inaction to diversifying across different asset classes, these insights offer an important framework for navigating the financial markets.