For many, investing is like a gym membership. Signing up is easy. Sticking around when it hurts is the real workout. Mutual funds are no different. The challenge is not in starting, but in staying put when markets sting. That’s why your first fund should not be the financial equivalent of trying to deadlift twice your body weight. It should be a warm-up set. Simple, steady and regret-proof. Start small, start right and let compounding do the heavy lifting. This piece is a handrail for beginners. If you’re already battle-tested in equities, carry on. This isn’t for you. But if you’re just starting out, we’ll help you pick a mutual fund that builds the habit without breaking your back. Because in investing, the goal isn’t to look like a superhero in year one. It’s to still be in the game in year 20 and beyond.
A beginner’s natural question
We love flexi-cap funds. In fact, we almost always recommend having one as part of your core portfolio, your staple fund. Why? Because flexi-cap funds, which can invest across India’s top 500 companies, have been consistently strong performers. On average, they’ve delivered over 20 per cent annualised returns in the last five years (as of August 28, 2025). For context; that’s nearly three times what a fixed deposit (FD) would give you. But we don’t think flexi-cap funds are for a brand-new investor. And that naturally raises a question: Flave we lost our marbles? Because if equity is such a proven path to wealth, why shouldn’t your very first step be in this direction? Why bother with “weaker” alternatives at all? Because the first lesson is behavioural, not mathematical. Equity creates wealth in the long run, but it also creates butterflies in your stomach in the short run. New investors often discover this the hard way. They begin with vim and brio, full of great expectations. Then the market wobbles. SIPs are paused. Redemptions happen at the worst possible time. And before you know it, equity is branded a lottery ticket best avoided. What gets lost in this drama is that the biggest risk in equity is not volatility, it is quitting too early. Beginners tend to confuse pain with unsuitability. Look at Chart 1. An SIP of ?5,000 started in January 2005 would have witnessed a 52 per cent crash in October 2008 from its peak in January 2008. On the other hand, the investor would see that an SIP in a short-duration debt fund barely flinched and kept moving in a straight line. Now, answer this truthfully: which line would your heart choose next month? The calm escalator or the roller coaster? The steps you take next are what matter. Now look at Chart 2. It splits the world into two investors after the 2008 fall. One stuck with the equity SIP. The other shifted the entire corpus to debt and continued all future SIPs in an average short-duration debt fund. The difference over the next few years is stark. The investor that continued with equity climbed far higher over the next 20 years, reaching a corpus of over ?54.2 lakh, while the other investor ended up at only ?24.8 lakh. The lesson here is not that debt is bad. The lesson is that leaving equity during a crash turns a temporary fall into a permanent detour. This is why beginners often find themselves on the horns of a dilemma. But this is where you should remember that your first fund shouldn’t be a trophy to flaunt, but a teacher to guide you. Its real lesson is patience, the ability to sit through a decline without abandoning your plan. And since you still want growth, going 100 per cent into debt isn’t the answer. The smarter start is to choose a fund that delivers progress w’hile cushioning the early blows, so you don’t mistake short-term pain for a wrong choice. Go hybrid Our recommended starting point is a hybrid fund through SIP. It keeps enough equity for growth and adds debt and arbitrage for a calmer ride. You will not top the return charts in every bull year, but you will avoid the kind of falls that make people quit investing. That trade is worth your time. For the uninitiated, a hybrid fund is made up of the following components: Gross equity (total equity held): Imagine the fund factsheet show’s 70 per cent allocation to equity. This is the gross equity. For example, if you invest ?1,00,000, then ^70,000 goes into equity securities. Hedged equity (equity made safe): Out of that 70 per cent, the fund manager may hedge 30 per cent using futures or arbitrage. Which means you still have exposure to equity, but the risk is protected. This part behaves like debt, giving low but steady returns. Net equity (actual risky equity): This isw’hat remains after hedging. It is the portion that truly experiences the stock market’s ups and downs. For example, ?40.000 (70,000 – 30,000) of your ?1 lakh is exposed to real equity risk and drives most of the- fund’s growth or volatility. Debt (safety cushion): The rest is in bonds and debt instruments. This part adds stability and cushions the portfolio when markets fall. Should this split matter to you? Yes, because taxation of hybrids depends on gross equity: If gross equity is below 35 per cent, the fund is treated like a debt fund, and gains are taxed at your income slab. If gross equity is between 35 and 65 per cent, you get equity-style taxation, but only if you hold for two years (12.5 per cent long-term capital gains tax (LTCG) beyond ?1.25 lakh exemption). If gross equity is 65 per cent or more, you get the most favourable treatment, equity taxation after just one year. This is why most equity-oriented hybrids keep gross equity at or above 65 per cent. It allows them to offer equity-like taxation while still controlling your net equity exposure for a smoother ride. When you walk into the world of hybrid funds, it’s like entering a supermarket with many flavours on the same shelf. Each type has a personality of its own. Some are risk-off, some more risk-on and some are just meant for parking your money for a short while. Let’s look at Table 3 on the previous page to know which one suits a new investor the best. The four faces of BAFs Equity exposure bands show the real personality of each balanced advantage fund type Aggressive Moderate Conservative Dynamic 100 % net equity Ranges show average net equity levels between the 10th and 90th percentile, post classification
What is BAF?
The table has helped us narrow down two hybrid fund types: Balanced advantage funds (BAFs) and aggressive hybrids. A BAF uses the same four components we just discussed: gross equity, hedged equity, net equity and debt. The trick lies in how the fund manager tweaks the balance. Arbitrage and derivatives are used to adjust net equity to a behaviour-friendly level. Remember: net equity is what you truly feel in your portfolio once hedges are factored in. Different BAFs follow different plavbooks to modify net equity exposure. Some rely on valuation anchors, cutting equity when markets look expensive and adding when valuations improve. Some follow momentum signals, riding trends as long as they last. While some depend largely on the manager’s discretion, guided by experience. On paper. BAFs (also known as dynamic asset allocation funds) have the freedom to swing their net equity exposure anywhere between 0 and 100 per cent. That sounds liberating. In theory, the fund can cut equity sharply when markets tumble and add back quickly when a rally is in sight. The promise is appealing: higher returns with lower risk. But labels often mislead. In practice, most BAFs do not use the full range. Freedom on paper doesn’t mean freedom in behaviour. The only way to really understand how a BAF works is to look at its actual net equity over time.
Classification of BAFs
Even though balanced advantage funds are free to move anywhere between equity and debt, most don’t keep shifting gears too much. They usually lean towards one style and stay there. So, we looked at the data for all 37 currently active funds and grouped them into clear buckets. The truly dynamic: A rare breed. These funds change equity allocations dramatically, often shifting by more than 35 per cent. Only four funds behave this way. The more rigid: They stick within stricter bands. Thus, these funds can be further classified into these three categories: Conservative: Usually below 40 per cent net equity. Only a small group resides here, just three funds. Moderate: Net equity is typically between 40 and 0 per cent. This is the largest cohort; 25 funds can be found here. • Aggressive: Hover near or above 70 per cent net equity. These look a lot like aggressive hybrids. About five funds fall here. Now, let’s tackle the most important question. If truly dynamic BAFs can swing from zero to full equity, do they actually deliver better outcomes over time? Or does all that activity just create churn without adding value?
Performance of the truly dynamic funds
It’s tempting to believe that dynamic funds can outsmart markets by ramping up equity during bull runs and shifting to debt when the tide turns bearish. But the reality is less flattering. Our analysis (Table 5) of three-year rolling returns since June 2018 shows that truly dynamic funds rarely outperform our in-house broad dynamic asset benchmark. Take Bank of India’s fund, for instance. Despite swinging its net equity anywhere between 21.7 per cent and 77.4 per cent, it managed to beat the benchmark only 16.5 per cent of the time. Even the best of the lot, Sundaram. could not clear the bar consistently, outperforming less than half the time, at 42.7 per cent. That’s because markets often turn faster than models or fund managers can react. Take valuations, for example. Sharp valuation swings make dynamic funds adjust with a lag, which whipsaws equity exposure and dilutes rebounds. When the price-to- earnings (P/E) ratio rises, markets appear expensive; when it falls, stocks seem cheaper. Dynamic funds often try to shift equity using such signals, but their timing usually lags actual market turns.
Figure 6 shows what happened during the biggest month-on-month valuation moves since June 2018. In March 2020, the P/E of the BSE 500 collapsed by 23 per cent, and dynamic funds failed to cut equity in prior months, ending up raising net equity sharply only after the crash. The buying came post-plunge, offering no cushion against the fall. Then came the rebound. As valuations surged in June. July and August 2020, funds were cutting net equity each time. That meant participating less in the very recovery that fuels future returns. You see the same lag in May 2022, when valuations fell 11.4 per cent. Funds trimmed very little in the fall month and increased exposure only the following month. The pattern is clear: these funds are dynamic in name but reactive in practice. They tend to add only after big declines without trimming ahead of major downsides. This results in higher churn and missed upside. That said, before blaming fund managers for failing to predict the future, remember that no one can consistently forecast the twists of an irrational market.