Choosing and holding

Ten chapters of mechanism. This one puts them in the order you would actually use them, and then deals with the harder half, which is not choosing.

Before anything else: what is the money for

The first question is not about funds.

Decide when you will need the money. That single answer determines what level of risk is acceptable, which narrows the category, which narrows the funds — in that order. Chapter 8 is why doing it in the other order is how people end up having to sell equities in a bad quarter.

Money you need within about three years does not belong in an equity fund, whatever the fund's record.

The ten questions

All answerable from the scheme information document, the factsheet and the monthly portfolio.

1. What category is it, and what does that category oblige it to hold? Chapter 5. Multi cap and flexi cap are not synonyms.
2. Direct or regular, and which am I buying? Chapter 3. Same portfolio, two prices, permanently.
3. What is the expense ratio, and what is the index equivalent's? The difference is the hurdle of chapter 10.
4. What does the portfolio actually hold? Chapter 7. Concentration, cash, and the top ten.
5. How much does it overlap with what I already own? The check nobody does, and the one that most often finds a duplicated fee.
6. What do the rolling returns look like, especially the worst window? Chapter 9. Not the three-year number.
7. Against which benchmark, and is it the total return version? Chapter 9.
8. How large is the fund relative to what it invests in? Chapter 10. A large small cap fund has a different job from the one that built the record.
9. Who manages it, and since when? A ten-year record under a manager who joined last year is not their record.
10. What is the exit load and its period? Chapter 3. It decides what an early change of mind costs.

Ten questions, one evening, and they will separate funds that look identical in any comparison table.

How many funds

Fewer than most people hold.

The reasoning is chapter 7's overlap check. Three large cap funds hold substantially the same companies; you have paid three fees for one portfolio and made your record harder to read. Adding funds in the same category is not diversification — the diversification already happened inside each one.

A small number of funds that do genuinely different jobs, where you can say in a sentence what each is for, is the shape to aim at. If a fund has no answer, it is a candidate for the previous paragraph.

When to sell, and when not to

The harder half, because most of the damage in mutual fund investing is done here rather than in selection.

Not reasons to sell:

• A bad quarter, or a bad year. Every fund worth holding has had them.
• The category being out of favour. A mid cap fund lags when mid caps lag; that is the product working.
• Another fund having done better recently. Chapter 9 — that is usually a fact about start dates.

Reasons to sell:

• You need the money. The plan worked. This is the point.
• The mandate changed, or the portfolio no longer matches the category you bought.
• The manager changed and the process depended on them.
• The riskometer moved up and the portfolio confirms it, and you did not sign up for that.
• The fund got too big for its strategy, visibly — drifting into larger companies than its category implies.
• It duplicates something you already own, and one of them has to go.
• Your own circumstances changed. The horizon shortened; the risk that was right is no longer right.

Notice the asymmetry. The reasons to sell are almost all about the fund changing or you changing. Almost none are about recent returns, and recent returns are what almost every actual sale is about.

Write it down

The single habit that does most for the outcome: before you invest, write one paragraph saying what the fund is for, when you will need the money, and what specifically would make you sell.

Then when the fund falls 30%, you have a document written by someone calm who knew this could happen. Your reasons either apply or they do not, and you find out by reading rather than by feeling.

This is not discipline for its own sake. Chapter 9 of the equity subject shows that the investor forced to sell at the bottom turns a fall into a loss, while the one who holds turns it into a bad few years. The only difference between those two people is usually whether they decided in advance.

The point

Decide the horizon first, then the category, then the fund. Ten checks from documents you are entitled to will separate funds that look identical. Hold few enough that each has a job you can state in a sentence — and write down in advance what would make you sell, because a bad year is very good at answering that question for you.