Why Equity Investment Works Best For Long Term Goals in Mutual Funds?

When it comes to equity-oriented investment, which is the best strategy? Should one adopt a short-term or long-term vision? Which perspective will yield better returns?These are a few questions that run through the minds of new investors getting ready to delve into equity mutual funds or equity directly.There are all kinds of investors out there. While some focus on holding a mutual fund or a stock over an extended period for capital appreciation, others believe frequent buying and selling can be fruitful. Their sole objective is to invest in equities for 1-2 years and then reinvest the money elsewhere to maximise returns. Let’s weigh both options to get a clearer picture.

A mutual fund's NAV (Net Asset Value) indicates a fund's valuation and prospects. However, the value can sometimes drift for a while due to various macro and micro factors that may impact the market performance, in general. As a result, the NAV can flounder in the short run.However, making investment decisions based on short-term patterns does not give a complete idea to the investor. It's essential to evaluate the investment returns in different scenarios and get some insight into their growth rate over a specified period.This is where the compound annualgrowth rate (CAGR) comes in handy.The percentage-based metric is one of the most accurate ways for charting growth and calculating returns on assets over time with a consistent rate of compounding.Let’s clarify this further with the help of an example.

Now, if you were to just look at 1-year records and invested in Fund X, you'd probably be tempted to redeem that fund and Fund Y to your portfolio instead.However, investors must not judge a funds performance on its 1-year return but review the average growth rate over (5/10/15/) years when it is compounding. The power of compounding can have a significant difference in the returns your investment makes. Let's extend this example further. Assuming you have Rs 1,00,000 to invest, here is how your returns will look like in Fund X and Fund Y.

Thus while Fund Y looked more attractive if you saw just the 1-year return of 60% vs 45% in Fund X, only a 5% difference in the CAGR of 5 years in both the funds amounted to a huge difference of Rs 90,000+. This is the power of CAGR.

It's no secret that investors explore the equity space to reap benefits from the rising stock prices in the capital market. But expecting overnight success, whether it is mutual funds or direct equity investment, is naive. The major drawback of investing in equities over a short horizon is unpredictability which enhances the risk element. The stock market can witness numerous ups and downs in a year leading to a change in the valuation of a fund over a period.A decline in equity value can prompt investors to get perturbed and redeem at a low value. This is not a wise move. Thus, gauging a fund’s performance on a year or so and changing allocation based on it is not a wise move. The trend of fund performance and returns keeps changing over time. Investors should focus on the fund’s track record and not be influenced by the previous year’s returns.

Investors who jump the gun and sell out when the market is headed south invariably miss out on gains when the equity segment turns positive. Equity investment is designed for the long haul. It grows in value over the years, provided you hold a quality fund.When the time horizon is prolonged, it’s easy to ride out issues like downturns and other market-related risks. Investors who do not panic and stick to their allocation in times of uncertainty and occasional price drops generally win.Investors with short-term goals, on the other hand, should steer clear from equity as the minimum period recommended for this sector is at least seven years. They can venture into balanced funds or even consider short-term debt funds. Also, liquid funds are known to deliver good returns in six months to one year.Buying and redeeming a fund frequently results in a disappointing outcome. Mutual fund, or even equity investing, requires discipline, patience, and commitment as growth in this segment is slow and steady. It cannot be witnessed in a year or two but takes time.Experts theorise the longer you stay invested in equities- the brighter are your chances of enjoying sustainable returns. So if you want to create a tidy nest of eggs for your golden years, invest in a good mutual fund based on your goals, risk appetite and track record of at least 5-10 years.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.