How to choose the best equity funds when the markets are high?

Investing in mutual funds has been one of the most attractive investment options for many decades from the time of its launch in India. But it still has a long way to go as even today there are only less than 10% of the population that invest in mutual funds. 

The average investor still considers them to be a risky affair. This is true to some extent, especially in equity funds as they are highly volatile compared to other categories of mutual funds like debt funds, index funds, fund of funds, etc. Hence it is necessary to invest in quality equity funds so they can not only provide high returns at the time of market highs but can also sustain the market lows. 

What are equity funds?

To invest in equity funds, investors first have to understand the meaning of equity funds. These funds are a category of mutual funds that invest predominantly in equity and equity-related instruments. The minimum investment required in such equities is 65% of the fund value.

These funds are riskier than debt funds or hybrid funds but can provide higher returns in the long term as compared to other types of funds. Equity funds are further classified based on the market capitalization of the company that the stocks belong to. Such classification is

1. Large cap funds (top 100 companies on the stock exchange based on market capitalization)
2. Mid cap funds (companies ranked 101 to 250th in the stock exchange as per market capitalization)
3. Small cap funds (companies ranked 250th and above in stock exchange as per market capitalization

What are the factors to consider for investing in equity funds during market highs?

As mentioned above, equity funds have the potential to generate the highest returns as compared to debt funds or other classes of funds. But to gain this advantage, investors are required to invest in such funds that will deliver decent returns even in the time of market slump. 

Selecting quality equity funds especially at the time of market highs can be tricky as the majority of the funds will provide good returns. Investors can follow the tips given below at such times to select equity funds that will help them in maximizing their returns and their wealth in the long run.

1. Investors should stick to their profile

The investor needs to stick to the profile with regards to the risk parameters, sector preferences, etc. During market highs, a particular sector may seem to be quite lucrative but if the investor has limited knowledge about the same as well as does not have the risk exposure required for such sectors, an investment in such assets may prove to be negative for the investor in the long run or during the next market slump cycle. 

2. Aim for long term performers while choosing the fund

Most investors get attracted to a fund based on the current returns provided by the fund. In the recent past, most equity funds have performed better on account of the market highs but that does not guarantee a consistent performance in the future. Investors have to also consider the past performance of the fund and other relevant details while making an investment decision that can show that the long term performance of the fund also looks promising. 

3. Look out for fund manager information

A fund manager is as essential to a mutual fund as a pilot to an aircraft or a captain to a ship. The ability of the fund manager to navigate market highs is as crucial as navigating the market lows. The fund manager during market highs should aim to rebalance the portfolio to weed out less performing assets. The profit on the same should be used to acquire more assets in the fund that can generate higher returns in the future. Hence, the investor must get information on the fund manager with respect to the previous funds handled by them or the previous market cycles handled by them. 

4. Consider the timing of the market

Timing the market to purchase a fund at the right time and the right price is a difficult task. When the market is high, investors usually wait for the prices to go down to make investments, this may lead them to miss good investment opportunities on account of market volatility. Equity funds, although volatile, have the potential to outperform the markets in the long run. Hence, instead of timing the market correctly, it is better to focus on the performance of the fund. 

5. Remove emotions from the decision making process

When investors make investment decisions based on their emotions, removing the objectivity from it, it is often a disaster waiting to happen. Emotion-based decisions rule out other important factors or constraints like investment style or strategy, investment budget, risk parameters, etc. investors should therefore know when to exit the market as well as when to not overexpose themselves on account of market highs. 

Conclusion

Market trends are often a contributing factor while making an investment decision, however, it is important to know the difference between a good equity fund and an equity fund performing solely based on market trends. This will ensure that the investor has quality equity funds in their portfolio and can achieve their investment goals. 

FAQs

1. Is it advisable to lock in short-term gains in market highs?
A. During market highs, most equity funds will rally with the market and provide good returns. This is the right time to cash in on funds that have generated lower returns and invest in good quality equity funds that will help in generating future returns. Investors should, however, be cautious of not redeeming good quality equity funds that can generate higher returns when they invest for the long term.

2. Can a risk-averse investor who has majorly invested in large-cap funds invest in small-cap or mid-cap funds during market highs?
A. Yes. Mutual funds provide a large array of choices for investors to invest their funds and enjoy the benefits of higher returns. However, investors have to be cautious of their risk appetite. Large-cap funds are relatively less risky as compared to small-cap or mid-cap funds. Hence, risk-averse investors should be aware of such risks at the time of investment to safeguard their interest.

3. What is the basic difference between equity mutual funds and debt mutual funds?
A. The basic difference between equity mutual funds and debt mutual funds is the asset allocation of the fund. Equity mutual funds invest predominantly (minimum 65% of the fund value) in equity and equity-related instruments. Debt funds on the other hand invest predominantly (minimum 65% of the fund value) in debt and debt-related instruments.

4. Are ELSS funds equity funds?
A. Yes. ELSS funds are Equity Linked Savings Schemes that offer tax benefits along with the potential to earn higher returns.

5. Is it better to invest in equity funds or pay off a home loan?
A. Home loan is long-term debt and usually takes at least a decade or more for the individual to pay it off. If the borrower has some surplus funds, it is better to invest them in good quality equity funds that have consistently performed better rather than paying off the home loan early. This will let the individual get the dual benefits of good returns from the equity funds and consistent tax benefits through timely payment of EMIs.