The simple, sensible route to create wealth

Getting rich through sensible mutual fund investments is very much plausible. Here, I would like to stress on the word 'sensible'. However, most investors fail to create wealth by not being adequately sensible with their fund investments. In the years that I have spent interacting with investors, I have found that the biggest mistake most of them make is that they treat equity funds as equity stocks and fixed-income funds as actual fixed-incomes.

In a recent conversation with Nilesh Shah, chief investment officer of ICICI (ICICIBANK.NS : 808.05 -4.35) Prudential, this observation came to the fore again. As per Shah, many investors keep moving in and out of equity funds while they stay put in fixed-income ones for long periods. This is exactly the opposite of what they should be doing. Ideally, fixed-income investors should be switching between different types of fixed-income funds as the economy goes through different interest rate cycles. However, many investors are under the assumption that fixed-income funds are equivalent - or even superior substitutes - to fixed-income investments like bank fixed deposits, PPF or post office deposits. They invest in these funds for long periods, not knowing that fixed-income funds are best suited for professional investors seeking short-term parking slots for their money.

Fixed-income funds are most ideal for professional investors like treasury managers of big corporations who need to park their money in relative riskless investment avenues for short periods of time. For individual investors looking for long-term avenues, fixed-income funds don't make much sense. This is basically because in periods longer than a few months, fixed-income funds rarely give returns superior than that of other asset types. At present, the average three-year returns of fixed-income funds vary between 6-8.5% per annum. This is in no way better than a bank FD or a post office deposit.

In fact, the Indian post office savings system is probably the most under-rated and under-utilised investment avenue. With XX per cent returns, government-guaranteed safety and zero TDS deduction, post office deposits are a gem and in many ways superior than fixed-income funds.

Coming to equity funds being treated as stocks, what I have observed is that a number of investors move in and out of equity funds as they would do with individual stocks. This defies logic, and is almost always counter-productive. Over the last couple of years, a vast majority of equity fund investors stopped investing when the markets crashed in early 2008. Then, they stayed away from equity funds till the semi-recovery of recent months, only to start investing again. This is nothing else but market timing - something that no sensible investor should do with funds or individual stocks. Common sense says that one should invest in equities funds for the long-term, irrespective of market gyrations. And particularly during a downturn, one should continue with the SIPs to reap its benefits later. But a vast majority of fund investors move in and out of funds, achieving nothing else but dwindling returns, if any.

Eventually, it all boils down the basics. It has been proven time and again that the simpler the investment strategy, the better returns it yields. And simple is always sensible.