When it comes to investing in mutual fund, people tend to get swayed and invest in large number of scheme with the presumption â€˜more the merrier‘. On the contrary, more funds might eat up your prospective returns. Financial Advisor Kripananda Chidambaram, guides us on creating right mutual fund portfolio.
"I have 9 mutual fund schemes in my portfolio, how good are they?"
This is one of the queries I got at my financial workshop I had conducted yesterday. Gosh 9 mutual funds schemes! When it comes to number of mutual fund schemes in ones portfolio most people seem to think ‘more the merrier’.
Why do we end up with so many mutual funds schemes in our portfolio?
One reason for this is a wrong understanding of the concept of diversification – people are so worried about one or two items going bad, that they try to compensate with two others. And so on. The fact is, a single mutual fund is itself a fair diversification – it often holds 25 stocks from different sectors. If you have about three such generic equity funds, you will likely hold most of the top 100 market stocks. More funds only lead to overlapping holdings of the same stocks, not further diversification.
Possibly the bigger reason for this proliferation is the questionable sales role of agents. Most of us buy funds only when pestered by agents. Till few years back, new funds paid out higher commissions to agents – so they were busy pushing new funds instead of tested old ones. Thankfully, the regulator has put an end to this practice by removing agent commissions altogether.
There is a third reason – we often want to try out something new. The idea is good, but the implementation is flawed. If you really look closely at your portfolio, you will discover that most funds are different in name only – they often hold very similar stocks. And if you have gone for several thematic funds, be assured that at any given time more than 2-3 themes are unlikely to succeed. So you would try and identify these 2-3 themes and invest; rather than throw several darts in all directions.
Just go for 3 funds .The basis for this thumb-rule goes back to our experience with mutual funds and stocks. Three well chosen mutual funds give you all the diversification you need. Any more only add to your complexity, and likely lower your returns. These three funds are useful for beginners and pros alike, since the fund managers are experts who are dedicated to manage your money well. People with no time or interest in finance need not worry – three funds can take care of your needs pretty well.
How to go about in selection of funds?
Remember, the first thing you always need to do before deciding on the fund:
Determine time- By when you would require the money. If you require the money within 3 years call it as short-term. If you may require the money between 3-5 years call it as mid-term and anytime above 5 years call it as long-term.
Follow the simple thumb rule:
- The investment is for short-term, then go for debt funds
- The investment is mid- term, then go for hybrid funds
- The investment is for long-term, then go for equity funds
The rationale behind this is as follows:
Debt funds provide safety of capital but the returns are relatively low. Investments that are for shorter period, priority is safety of capital over returns hence debt funds are preferred.
Equity funds gives you scope to make higher returns provided they are invested for longer periods. For investments that are long-term, inflation is the major cause of worry. Equity funds have the power to blunt the effects of inflation.
Equity mutual funds are further divided to cater to different segments of people.
Further to identify the type of equity fund suitable to you:
Define-The purpose of the investment. If the purpose of the particular investment is to meet life goals higher education, retirement, marriage, purchase of home, etc call it as core needs. If it is for general wealth creation call it as satellite needs.
To choose the appropriate equity fund to meet your long-term need follow these simple rules:
- In case you are investing for core needs then choose a diversified large cap fund or an index fund
- In case you are investing for satellite needs then choose either a thematic or sector fund.