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How to diversify portfolio through Mutual Funds

In any investment portfolio, two strategies are very important - Diversification and Asset allocation. It is common knowledge that mutual funds provide diversification. But if you choose your mutual funds carefully, you can design a good asset allocation portfolio too. Read this space to know how you can have diversified portfolio through MFs.

April 23, 2013 / 05:28 PM IST

In any investment portfolio, two strategies are very important. One is diversification and other is asset allocation. Many times people confuse these as one and same but in reality both are very different from each other. Basically diversification is spreading your investment within the same asset class but in different companies or maturities (as in debt).Whereas asset allocation means, spreading investment into different asset classes. It is common knowledge that mutual funds provide diversification. But if you choose your mutual funds carefully, you can design a good asset allocation portfolio too.

As you all know that mutual funds are not an investment in itself, but are an investment vehicle. It is an investment vehicle in the sense that it allows people to invest in different assetclasses through a professional management. As they say, you don’t invest in mutual funds but through mutual funds. Nowadays mutual funds provide exposure to almost all asset classes like equity, debt, gold and real estate. They area well managed and diversified investment vehicle. Hence one need not look at anything else,as one can design his entire investment portfolio using mutual funds. Let me explain to you some of mutual fund types, which will help you in designing your asset allocation.

1. Equity Oriented Mutual fund:

Mutual funds are commonly known as Equity Mutual funds and equity is popularly known as risky asset class. But for growth oriented portfolio the presence of equity is inevitable. Though there is the option of going into direct equity (shares), but if you are concerned about the risk part then mutual funds should be your only choice. You can design your portfolio as per your risk appetite using large cap, mid cap, multi-cap, sectoral funds etc. Company’s risk is taken care of by diversification, liquidity risk is taken care of by management and management risk is taken care of by SEBI.

2. Debt oriented Mutual funds:

Debt investment is what you do in bank fixed deposits, post office savings, tax free or infrastructure bonds etc. These are also called as fixed income investments. Debt mutual funds also help you invest in such instruments but indirectly. These funds are not very popular among investors and are seen aslow yielding investments. Most investors are happy with the traditional debt exposure through bank fixed deposits. But in reality, debt mutual funds are one of the best investment tools  that along with the benefit of stable income, provide tax efficiency and capital appreciation too. And if used judiciously in different interest rate scenarios, one can make good money, sometimes even more than equity investments.

3. Gold savings funds or Gold ETFs

We Indians are emotionally connected to gold. Gold has always been part ofour personal assets. If you believe that gold is an asset class which can be used as an investment apart from being used just for personal use, then gold ETFs are the best vehicle through which you can directly invest in gold. This way you need not pay the making charges or custodian charges as you do in case of gold jewellery.Gold as an investment class is always treated as a hedge against inflation but in the last few years due to its exponential growth, many havestarted looking at it as one of the major investment asset too. But in terms of asset allocation the ratio of gold in your portfolio should not be more than 10%.

4. Real estate venture capital Funds

Mutual funds do notinvest directly in real estate, due to regulatory restrictions. But some fund houses time and again, with the approval of SEBI(regulator),launch venture capital schemes for real estate investors. These schemes are meant for high net worth customers as the minimum investment is on higher side. Moreover SEBI treats these funds as the most risky ones so it has recently marked these as Alternative Investment Funds (AIFs) and has announced separate guidelines for its regulation. Those with the requisite amount of funds and want exposure to real estate through professional management can allocate some portion of their money into such funds.

5. Asset allocation funds

Every asset allocation once fixed has to be reviewed periodically, so that necessary rebalancing can be done whenever required.  Investors who are active on this front, can easily manage this very well. But those who find this difficultcan look at asset allocation funds. These funds come in different variants for different risk profiles like conservative, moderate or aggressive.  Some fund houses have funds which allocate as per the market risk. They don’t take the personal risk into account but allocate as per the price earnings ratio or price to book value ratio of the broad market. This type of funds may also suit some investor’s personal risk appetite.

Every investment planning starts with understanding of risk profile and goals.Asset allocation is decided keeping in mind both these factors. Equity and real estate are counted as aggressive growth oriented, but volatile and risky investments. On the other side debt and gold are treated as a relatively safe asset classes. While selecting a particular asset for investment depends on the risk profile, goals too have to be kept in mind, so you can decide on an optimal allocation for achievement of those financial goals.

The author is a member of The Financial Planners’ Guild, India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards.