How to keep your risks at a bare minimum while investing in equity

By Dhirendra KumarHopefully, by now my columns have convinced you that most of your long-term investments should be in equity. The next question to be tackled is how to do this. Let’s look at this problem step by step.For those who have never invested in equity, it’s hard to know where to start. However, everyone knows there are two distinct ways of investing in equity. One is to choose stocks and buy and sell them yourself. The other is to invest through equity funds. The final goal is the same: to benefit from the superior returns that equity investing offers. However, in terms of what you do, the two routes are completely different.Unless you are an expert investor, or are willing to put in the considerable amount of time and effort required to become one, it does not make sense to invest in equities directly. Therefore, for beginners, the choice is quite straightforward: you must invest through mutual funds. I’m not saying that an individual can’t be successful by investing directly. There are many who invest by themselves and get great results. However, in general, the odds are unfavourable. For every 100 who try, perhaps five or 10 will be successful. An even bigger problem is that even the few who succeed will probably do so only after many failures, and each of these failures will cause them some losses.For most of us, the goal is to simply get higher returns from our savings. So this business of learning through losses turns out to be a deal breaker.Equity-based mutual funds solve all these problems quite simply. A major advantage of investing in equity through mutual funds is disciplined diversification. Fund managers operate within an institutional framework which enforces certain ground rules of investing. These could be a set of rules defining the investments, such as there must be at least 15 or 20 stocks with no less than a certain percentage of the total portfolio. The stocks must be spread over at least five sectors with no less than a set amount from each sector. A certain percentage must be held only in large companies because they tend to be more stable in difficult times. Such rules define a framework which ensures that the portfolio stays diversified and safe from shocks that may hit individual stocks or sectors. Individuals who manage their own stock investing rarely have the knowledge or the discipline to do these things.Being able to start investing in small and flexible chunks is another big advantage. If you try to build a diversified portfolio with stocks by buying them directly, you’ll need a relatively large sum of money—at least a few lakhs —to begin with. In mutual funds, you can start off by owning the same with a few thousand rupees. You can invest regularly and automatically with a fixed amount every month, and you can actually save tax under Section 80C by investing up to Rs 1.5 lakh a year in designated equity mutual funds.There’s one final advantage that results in much higher returns from equity mutual funds in the long term. All equity portfolios need some buying or selling as individual stocks become more or less desirable. If you are trading stocks yourself then these transactions will attract a tax liability. However, in an equity mutual fund, this trading is done by the fund manager inside the fund. You don’t incur a tax liability because you haven’t made transactions yourself. There’s a further multiplier to the tax saved, because the money becomes part of the investment, thus gaining even more. For long term investments that compound over the years, this can make a huge difference.Taken together, this is a persuasive list of reasons to choose mutual funds over equity. Of course, if you are not convinced, you can still go ahead and invest in stocks directly. It’ll be a tougher task, but you could well be among those who find success.(The author is CEO, Value Research) 63949935 63854528

from The Economic Times https://ift.tt/2raXDhz