Mutual Funds

Fund Query: Why you should own equity funds for the long term

Aarati Krishnan | Updated on July 24, 2021

I am 30 years old, self-employed and have been investing in diversified equity funds since 2017. I have redeemed a few funds during the last one year to invest in land. The goal is wealth accumulation. The average return on my funds is at 50 per cent now. Should I redeem all my investments in funds except for the ones made in the past year? I have heard that MFs should be for the long term and not redeemed in-between to get the best out of them. Why is it not good to redeem even if the NAV is at an all-time high? I do not need the money immediately but would like to keep it ready in case there is an opportunity to invest in land or other assets.

Gajanan Pai

To understand why you need to own equity funds for the long term, you need to know how stock market investing works. Equity funds, as you may know, own a diversified portfolio of shares in listed companies. Each share in a company represents a part ownership in the profits it generates. Shares create wealth for their investors in the long run in two ways. As the company’s profits compound, the value of your share rises in tandem because they now represent a share of a larger profit pie. As its profits expand, the company may also increase the dividends it pays to its shareholders.

Now, in a bull market, it may appear that there is no such rationale to stock price movements and that they are driven entirely by sentiment. The capital gains you make on stocks during bull phases through share prices running way ahead of growth prospects may not last. But in the long run, stock prices are driven mainly by a company’s profit performance. The share price gains and rising dividends that good companies deliver in the long run, as a result of their business churning out higher profits year after year, compound wealth at a rate that few other assets can match. This is why it is essential to hold equities for the long term to make meaningful returns.

When you hold a diversified equity fund, its portfolio of companies can deliver consistent share price gains and dividends over the years that keep adding to the fund’s NAV and thus to your returns. If a business fails or doesn’t perform particularly well, a well-managed fund will replace it with a better candidate.

This is why you are urged not to sell your equity funds, if they are performing, just because the past returns appear good. There are several diversified equity funds in India that have delivered a 15-20 per cent compounded annual return if held for the last 20 years. Even holding an index fund owning Nifty50 stocks for the last 20 years would have yielded a 15 per cent CAGR. A sum of ₹10,000 invested in a Nifty50 fund in 2001 would have grown to about ₹1.64 lakh today through this compounding process. Investors who redeemed their equity funds once the ₹10,000 became ₹15,000 would thus have lost out on the huge wealth creation opportunity that came thereafter.

But that said, as stock prices are subject to big booms and busts, it isn’t a good idea to have all your investments in stocks or equity mutual funds. For good risk-adjusted returns, it is best to diversify your investments across multiple asset classes, be it equities, debt, FDs, real estate or gold. While deciding on this allocation, you need to factor in your age and life stage, risk appetite, need for liquidity and safety of capital and taxation, apart from return potential.

Land can at times (though not all the time) exceed the capital appreciation delivered by equities, but it suffers from the disadvantage of not yielding any regular income, being a somewhat illiquid investment (you can’t sell it as easily as equity funds if you need cash) requiring a concentrated exposure (you put a lot of money in one locality which may or may not prosper).

In light of all this, there can be three good reasons to sell your equity funds today. One, you own too much equities and too little of other assets and want to rebalance your allocation. Two, you need the money within the next 3-5 years (if the stock market crashes, recovering your capital can take longer than that). Three, you have a moderate risk appetite and cannot take significant losses to your capital from any market reversal.

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Published on July 24, 2021

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