Notwithstanding the day-to-day noise around stock markets, equity continues to be a favourite choice for long-term investments. Before plunging in, remember that by design, definition and style equity is a volatile asset class. However, a longer investment horizon can reduce risk substantially. For instance, the 29-year history of the Sensex shows that annual returns on the Sensex for a 1-year holding period has moved in the wild range between –52% and +265%. But with a 5-year holding period, the average annual return range is far superior, between –5% and +55%. This proves that for a short-term investor, equity is a very risky asset.
Diversified equity funds, for their inherent diversification tend to reduce your risk of losing money sharply. Simply put, these funds build a portfolio of stocks, chosen from various sectors and reduce the risk associated with a particular industry. A sector fund targeting a specific industry is susceptible to wider price-swings than its conservative counterpart - the equity diversified funds. The trade-off for balancing risk and return in a diversified portfolio is that your overall return might be lesser than what you could get in a concentrated portfolio. In the long run though a diversified portfolio helps you post steady returns and comprehensively beat the returns raked in by all other asset classes such as bonds, gold, etc. Though that diversification doesn't guarantee positive returns every year, it definitely reduces the risk on your investments. The point to remember is that risk is reduced not eliminated. The rules of sound investing are diversification, balance, and a long-term orientation. These should always be kept in mind when investing in equity funds.
Diversified equity funds will serve your purpose provided your investment span is at least 5 years and more. So, first consider your objective and the timeframe. Then evaluate the fund's return consistency and investment strategy. A look at the sector allocation will tell you about the fund's strategy. After that, decide which of the funds (in the category) will you put your money into. Pick up a truly diversified, yet actively managed equity fund. An actively managed fund will also ride the opportunities thrown up by a particular sector while being prudent with its exposure limits. And if the fund changes its investment strategy during your stay, do reconsider if the realigned strategy agrees with your comfort level. But most importantly, invest regularly.
