How many Mutual Funds are good enough in a portfolio

All investors are different, every investment is unique. Before deciding on the number of mutual funds, you have to identify your financial goals and invest accordingly.

How many Mutual Funds are good enough in a portfolio

There is no perfect portfolio that would work for everyone. You have to be prepared by doing proper research and finding out what works for you.

Therefore, unless you are very well versed with the markets and have expertise in mutual funds, a good rule of thumb would be to own.

• In a debt category, one or two funds are good. You must reflect on your time horizon and associated taxation.

• You can select one index fund or a combination of two funds in a large-cap category. If you add another fund, there will be a high level of overlap in the large-cap portfolio.

• You should invest in two small-cap and two mid-cap funds. Usually, the overlap in these categories is low if the chosen funds have a different strategy (value/growth).

• In the case of a foreign mutual fund, one fund is fine as far as the underlying is an index of a foreign country (NASDAQ/NYSE).

Election year and the stock market return

A few months leading up to election time are filled with higher volatility which over time, especially after the election, subsides. In the last so many years market has behaved, rationally or irrationally, based on the comfort of political stability.

Election Year and the Investment Return

There is a weak correlation between Lok Sabha election and investment return. However, there is a high correlation between business profitability and investment return. Similarly, state elections are more relevant to local businesses impacting business profitability. A lot of state-level politics can have an impact on running businesses/factories in that state.

If you remember many years back, West Bengal did not let Tata manufacture Nano cars in the state. Tata Group had no choice but to leave West Bengal. It’s a different matter that Tata Group realised that Nano was a bad decision but still the entire event created an image of West Bengal as not a business-friendly state.

Investment community preference is towards political stability, irrespective of which party forms the government. As part of a stable government, we need a party to win majority Lok Sabha seats and that will ensure the next five years of stability. In a few days, we will start hearing a lot of exit polls and what each media house thinks. These exit poll results can have a short-term effect on markets especially if the indication is towards an unstable government.

I have no idea who will be forming the government, and I am pretty sure no one does. We also suffer from recency bias. We assume that 2019 will be repeated but who knows what. Atal Bihari Vajpayee was a great leader who made India a nuclear state and won the Kargil war but lost the 2004 election just because onion prices had skyrocketed. Interestingly, even Congress was not prepared for the 2004 win.

As an investor, I must maintain a neutral stand. I should be prepared for any outcome. I think if a stable government is formed that is expected by the market, we may not see a lot of market movement because a lot of that information is already captured in the recent bull run. However, if a stable government is not formed that will be against market expectations. This will lead to a short-term correction in the market. It would be silly for me to put a number to that correction. However, a smart investor will be prepared for any such correction. Business profitability and growth will drive valuation as it always does.  

Dr Kalam in his book, Ignited Minds talks about dreams, thoughts, and action. Dr Kalam also talks about developing a belief system. If we want to see our nation in the top league of nations in the world, we must also do our best and have the right belief system. A mere stable government will achieve nothing. Post Indira Gandhi’s assassination, Rajiv Gandhi came with an overwhelming majority but within a few years, India witnessed the most embarrassing moment. The world had no confidence in India’s debt repayment capability. IMF lifted gold from RBI facility. In fact, in the late 80’s, Pakistan was a much stronger country than India. In just three decades, India has achieved tremendous growth.

I hope we see a majority government at the centre and also see a solid opposition so that ‘We The People’ of India can benefit from being the largest democracy in the world.

There are only two ways to earn any investment return

As per my understanding, an investor can earn a return primarily in two ways. First, to follow the market. And the other, stand against the market.

Investment Returns

What do I mean by following the market?

It means following a trend. As far as the investor can be in the direction of the market at an early stage of the trend and leaves the market before the trend ends, the investor stands to gain. Unfortunately, retail investors join the trend towards the end of the cycle.

It may sound very easy that you can follow the trend and earn well. But to do this consistently is not easy.

The other way to make money is to invest by being a contrarian investor.

What does being a contrarian mean?

Well, it means standing against the market. In simple terms, the investor thinks that the market is behaving irrationally and takes a position which is contrary to the trend of the market.

Again, it is not easy to be a contrarian investor. Financial analysis can indicate a lot of great opportunities but to stand against the market is psychologically not easy. It is with the hope that in due course market will realise and the share price will bounce back.

How can a retail investor benefit from following the market?

Often magazines and newspapers are filled with charts and buy/sell recommendations. It is a poor level of research and should not be acted upon.

A relatively easier way to follow the market is to invest alongside a broad market index. An investor can simply invest in ETFs or index funds. This way the return of the market with the return of the investor.

Another option to be with the trend is to allocate funds in 4 to 5 mutual funds across large-cap, midcaps, and small-cap. The reason I say mutual funds are also following the market is primarily because most of the mutual funds will have large number of stocks ranging between 30 to 40 stocks. Running a contrarian position within a mutual fund may not be easy.

This is precisely the reason when the markets fall, mutual funds also fall, and when the market rises, mutual funds also rise. One of the ways to identify a good mutual fund is to observe mutual fund performance during a falling market trend. A mutual fund holding quality businesses will fall less than the market.  

Now the more complex option i.e. being a contrarian investor. If you want to dig deeper into this approach, there is a very good book written by David Dreman, Contrarian Investment Strategies: The Psychological Edge. The book explains the benefits of being a contrarian investor and how to evaluate such opportunities.

There are many contrarian ways, but I will restrict myself to less risky ones. Identify quality companies that is companies generating high returns on capital over a long period say 10 years plus, have low or no debt and currently going through some tough times. These tough times could be qualified as temporary issues related to any product, some notice by a regulator, a bad quarter, industry headwinds, et cetera. The key is to dig deeper into the company and figure out whether the problem is temporary or permanent. Usually, problems are permanent if they are related to bad capital allocation decisions that is acquisition or unethical practices by management.

The reason contrarian investors make money over due course is because the price at which they enter is low. In case there is negative news against the company, often the price is smashed by the market. Hence, a great opportunity for investors to get in.

However, it is not an easy task. There are a lot of psychological hindrances. One of the ways of addressing psychological issues is to dig deeper into the company and understand the issues from a variety of angles. What this means is rather than looking only from a financial sense, you should be able to look at a problem from a variety of perspectives. On one hand, no degree can teach you this and on the other hand diverse reading can help you build this understanding.   

Different investors can have different ways whether to be a contrarian or be with the trend. However, the idea is to be aware of what kind of investor you are. Often, I see people claiming themselves to be long-term investors, but they are focused on daily price moves.

It is better to be emotionless when it comes to investing whether you follow the trend or you don’t. There is a lot of humbleness that great investors have and that primarily comes from acknowledging that even with the best of effort they still need a lot of luck.

I hope your investment journey is filled with a lot of learning and a lot of luck.