As markets rise, here is a roadmap for new investors to avoid accidents

Be mindful of risks and avoid overly aggressive fund strategies at the start of your investment journey

A record 1.2 million new investors entered mutual funds in July, the highest since December 2021, spurred by strong stock market performance and the attractive returns of equity mutual funds. These new investors must approach the market cautiously. 

Adopting overly aggressive strategies without considering risk could lead to significant losses during the next downturn. If such losses force them to exit the markets prematurely, that would be a setback, as long-term investment in equities is crucial for wealth building.

Clear your debts

Pay off your debts, especially high-cost ones like personal loans and credit cards, before starting your wealth-creation journey. Earning 12-14 per cent from investments won’t benefit you if you are paying 16 per cent in interest cost.

Avoid getting scarred

New investors must avoid early setbacks. “Steer clear of highly volatile funds like sector, thematic, and smallcap funds, even if they have delivered high returns recently,” says Deepesh Raghaw, a Sebi-registered investment advisor.

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Three-bucket approach

Investors should divide their corpus into three buckets: the safety bucket, the short-term bucket, and the long-term growth bucket.

The safety bucket is for emergency expenses. Investors should accumulate six months’ worth of household expenses, including life and health insurance premiums, here. This can be achieved by starting a systematic investment plan (SIP) in either a liquid or an arbitrage fund.

Next is the short-term bucket, which should cover expenses anticipated over the next five years, such as a down payment on a house. “To meet this goal, investors may choose a short-term debt fund. If the goal is slightly flexible, they may even consider an equity savings fund, which has a small equity component,” says Arun Kumar, head of research, Fundsindia.com.

Next, investors may allocate their remaining monthly savings to the long-term bucket. A rule of thumb is to allocate 5 per cent to the safety bucket, 5 per cent to the short-term bucket, and the rest to the long-term bucket.

The long-term bucket focuses on goals such as children’s education and marriage, and one’s retirement, which may have a time frame of 10, 20 years or more.

“Initially, if the amount you plan to invest over the next two years exceeds 30 per cent of your current corpus, you may invest almost entirely in equities,” says Kumar. However, if your future savings over the next two years will be only, say, 10 per cent of your current portfolio, then 20 per cent (30 minus 10) may be allocated to fixed income. The funds in fixed-income instruments can be shifted to equities during a downturn.

As the portfolio grows, investors may use the 110 minus age rule of thumb to determine their equity allocation, adjusting it for risk appetite. About 10-15 per cent may be allocated to gold and the remainder to fixed income.

“Investors should assess their comfort level with potential losses, focusing on absolute numbers rather than percentages, when deciding their equity allocation,” says Vivek Banka, cofounder, Goalteller.

Begin with stable fund categories

Raghaw suggests that retail investors start with low-risk products like a Nifty 50 index fund or a balanced advantage fund. Next, he says, investors must acclimatise themselves to the inherent volatility of equities. To achieve this, he recommends gradually moving into slightly more volatile products, such as a Nifty Next 50 index fund, midcap fund, and  smallcap fund.

Kumar also recommends starting with a Nifty 50 index fund and, over the next two to three years, transitioning into more diversified index products, such as the Nifty Large and Midcap Index Fund. “Once comfortable with market volatility and passive investing, you may consider active funds. Opt for five funds across different styles: value, quality, momentum, mid and smallcap, and international,” he says.

Banka recommends new investors start with a flexi-cap fund, and later add a large and midcap index fund and a Nifty 500 fund for broader market exposure.

Prudent position sizing

Retail investors should also manage their position sizing carefully, avoiding the allocation of a large portion of their net worth to equities via lump-sum investments. A sharp market correction can lead to significant losses. Instead, they should increase their exposure gradually through a staggered entry approach, using systematic investment plans (SIPs).

Individuals unfamiliar with fund selection often fall for heavily advertised schemes, or those pushed by distributors (typically new fund offers on which they earn higher commissions). Such traps must be avoided.