How to control our emotions when investing in mutual funds

Every time the market hits an all-time high, many investors get jittery. 

Questions like “should I book profits now?” “Should I stop investing now?” start doing the rounds in social media. This article discusses a simple way to handle our emotions when investing in mutual funds or any capital market-linked product.

The adage, “show me your friends and I will tell you who you are” can easily be modified to suit investors who ask seek counsel on social media: “ask your question, and I will tell you how well planned you are”. Yes, most people who ask questions in personal finance forums on Facebook want to manage money without a plan (and often get angry when we point out the obvious).

Members of this group admitted in a poll (held months before the March 2020 crash) that 1st-time investors would never buy MFs if they knew about risks! So poor understanding about the product and unrealistic expectations are the most common reason investors abandon mutual funds, buy every shiny fund they come across etc. 

This lot is beyond redemption and is not the subject of this article.

Let us focus on investors’ who appreciate 

(1) why they need equity in their long-term portfolio; 

(2) the importance of goal-based investing and asset allocation. 

Many such investors find it hard to stay focused after investing and worry about doing the right thing.

 We shall consider an idea which appears to be an oxymoron at first sight: emotional logic. It is only an idea, and like all ideas hard to implement, however, my hope is at least a few reading this would appreciate its value the next time they think of deviating from their investment plan.

‘I believe equities remain the best asset class for long-term wealth creation’

1.      Why are stock markets hitting new peaks at a time when the GDP is in contraction mode? Is the rally for real?

Stock markets are forward looking. They work on anticipation of the current and future economic outlook. The Covid impact on the economy was predicted in March and hence the markets corrected. As we stand today, the recovery theme has played out well as markets saw renewed interest for domestic equities from all market participants, including FPIs and portfolio investors. Earnings have backed investor expectations and we believe markets are poised to remain positive sans Covid.

 

2.      Why are foreign investors pumping money (over Rs 1,60,000 crore in 2020) into Indian markets?

India has been a standout economy in the global context. Especially in the emerging market world, strong political stability and a robust recovery cycle has been a beacon for international investors. In the post-Covid world, where the world is awash with central bank liquidity, India has been getting a disproportionate share. As an opportunity, India continues to remain an attractive destination for global growth investors since they are increasingly comfortable with the structure of the economy, policy and regulatory framework. The government over the last five years has actively worked to make India more business friendly and this is now paying dividends.

 

3.      My assessment on the debt market? Have interest rates bottomed out?

Domestic bond yields have followed the operative rate downwards as the RBI and the government have emphasised bringing rates lower through policy action and accommodative monetary policy in an attempt to spur growth. While the money market curve and the 3/5-year space have broadly followed suit, longer dated papers especially corporate bonds have remained somewhat anchored. The recent RBI commentary is a clear indication that the RBI intends to keep rates range bound. Unless we see a huge fiscal consolidation or downward growth or inflation shock, rate cuts look unlikely.

For 2021, I believe investors will be best suited to go up the duration curve which would serve investor needs of a higher risk reward. We anticipate the RBI will maintain rates at current levels over the course of the next year at minimum, post which I believe a gradual rising rate environtent will ensue on the back of a recovery in the economy.

 

4.       The market, Which is at a record high, safe for us (small investors/Retail investors)?

From a grim March to a euphoric November, equity markets have been on a rollercoaster ride, a reminder that equities are a volatile yet rewarding asset class. Small investors have increasingly participated in equity markets through the mutual fund route and through direct stock investing.

The value of the Sensex and the Nifty is just a number. We have seen this time and time again. As India grows, financial markets will rise commensurately to reflect this growth.

As I always say why investing regularly is important. Timing the market rarely works and hence investing is a continuous process which when followed diligently has rewarded investors over the long term regardless of when they entered the market.

 SIP flows have been a testament to this understanding. For the better half of three years now, I have seen unwavering SIP flows.

One must remember that markets have been volatile during this phase. Investors who stick with their investment commitments have reaped the rewards of staying patient. I believe equities remain the best asset class for long-term wealth creation and should form some part of every investor’s portfolio.

Way ahead

The month of January 2021 witnessed considerable easing of momentum in equity markets as investors resorted to profit booking after an unprecedented rally in the latter months of 2020. The Nifty 50 index fell by 2.5% to 13,634. Meanwhile, the Nifty MidCap 100 and Nifty SmallCap 100 index rose marginally by 0.8% and 1.6% respectively.

FIIs scaled back their aggressive investment strategy into the Indian equity markets pouring in Rs. 14,512 crs, the lowest since October 2020. Meanwhile, MFs continued their selling spree removing Rs. 12,980 from the equity markets.

FIIs scaled back their aggressive investment strategy into the Indian equity markets pouring in Rs. 14,512 crs, the lowest since October 2020. Meanwhile, MFs continued their selling spree removing Rs. 12,980 from the equity markets.

The union budget announced on Feb 1st 2021, brought with it extreme euphoria as the finance minister chose to take The Path Less Trodden. The budget gave a clear indication of the government's focus on growth through capital expenditure without worrying about the fiscal deficit in addition to adopting cleaner accounting methods.This Budget is historic in a way that breaks the shackles of fiscal constraints. By increasing capital expenditure, the multiplier effect on the economy will be significantly more impactful against the previous route of revenue expenditure which results in limited gains.With significantly lower Covid-19 cases, a well-executed vaccine drive, high level of liquidity in the markets and a pro-growth budget, it is not difficult to be optimistic for 2021. Also providing support were earnings upgrades that continue at an unprecedented pace as activity continues to normalize. Along with the earnings upgrades, India also experienced upgrades to GDP estimates. As per RBI, the GDP for FY22 is set to grow at 10.5%, albeit on a lower base.On the global front, While the UK is struggling to stay afloat due to the rapid spread of the new variant of the virus, the US economy is rejoicing due to the Biden administration coming to power. China remains the fastest growing economy in the world and is projected to be the only country to post a positive growth this fiscal. There are clear signs of economic progression as oil prices are nearing long term average levels and a slight retracement in gold prices, indicating revival of risk appetite among investors.The focus for us has been to deploy the remaining corpus, and we are in the process of actively evaluating opportunities for the same. Current equity market valuations at 41.4x look exorbitant and discount even the highest level of growth expectations. The current Quarter earnings YoY growth for Nifty is at 16.16%(34 out of 50 companies’ results are published).  Due to the lack of any margin of safety, we advise investors to remain cautious and take advantage of any correction from this point on for long term investments.On the Fixed Income front, a higher-than-expected fiscal deficit announced in the budget leading to a higher-than-expected borrowing program to the tune of 12 lac crores led to an uptick in the 10-year G-sec rate by 11 bps to 6.06%. Presently, we are of the opinion that the heightened borrowing by the government will not affect India’s credit rating or ability to service timely repayments of loans. Much depends on how the government engages with rating agencies and divests in a timely manner. With CPI inflation finally cooling to 4.59% after months of breaching its upper limit of 6%, the real returns to a foreign portfolio investor continues to look attractive.We believe that the yield curve is likely to remain steep this year. Due to the crash in yields for ultra-short term, we believe any investment for a period of 1-2 years should be made in Arbitrage funds due to the pickup of spreads in the category. Banking and PSU debt funds can be considered for a greater than 2-year investment period.

ULIPs now taxable like mutual funds!

Finance Bill 2021-22 has proposed to tax gains from ULIP with a premium of more than Rs. 2.5 lakh per year to remove the disparity relative to mutual funds. This means from Feb 1st 2021 if you buy a new  ULIP with a premium of more than Rs. 2.5 lakhs the maturity proceeds will be taxed identically to mutual funds. Death benefits continue to remain tax-free regardless less of the premium amount. This will reduce mis-selling of ULIPs.

This rule applies to the sum of the premium of the ULIPs purchased on or after 1st Feb 2021. For example, if you buy three ULIPs and the total premium is above Rs. 2.5 lakh then the gains from all the three ULIPs will be taxed like mutual funds.

Senior citizens 75 and above need not file IT returns subject to conditions!

Budget 2021 has only one offering for senior citizens. If some conditions are met, those aged 75 and above need not file income tax returns. They have to pay the necessary tax but need not file returns.

The conditions for exemption from filing ITR from 1st April 2021 are:

1. The senior citizen should be a resident and should be 75 years of age or more during the financial year for which tax has to be paid
2. He/She must receive a pension and interest income from the same bank! Different banks are negligible.
3. Only certain specified banks are allowed
4. A declaration should be given to the bank

Another interest income from any other source or any kind of capital gains would mean the person has to pay tax. Thus this benefit will not help many!

How employee contributions over 2.5 lakhs gets taxed like a FD

Finance Bill 2021 has proposed that employee contributions over 2.5 lakh will be taxed as per slab.

Assume that your EPF balance as on 31st March 2020 is Rs. 10,00,000. The employer contribution is, Rs. 20,000 a month; The employee contribution is Rs. 20,000 a month or Rs. 2,40,000 a year (FY).

In this case, there is no change in rule and nothing need to be done. Suppose the employee decided to invest via VPF Rs. 5000 a month. The total annual contribution by the employee is (5000 x 12) + 2,40,000 = 3,00,000.

If the EPF rate is say 8% then 8% of (3,00,000 – 2,50,000) = Rs. 4000 should be shown as income while filing ITR and this will be taxed as per slab rate.