Wish to start building your mutual fund portfolio from scratch? Or maybe you already have purchased funds and want to reboot it? There's one thing you need to understand that there is no such thing as a "perfect mutual fund portfolio". There can be numerous reasonably good portfolios, but there's nothing like one-size-fits-all in mutual funds.
So how should you build a mutual fund portfolio?
The very first thing to decide here is what are you investing for or what's your goal.
For common people, the best way to manage investments is to have a separate portfolio for each financial goal. Or club similar goals and have portfolios for them. For example - retirement portfolio, child's education (or marriage) portfolio, etc.
Once you start thinking in terms of goals, you have precise answers to questions like how much money you need for the goal, when you need it and what returns you should be targeting.
For example - you need Rs 30 lakh for your son's higher education in 10 years. Or you need Rs 15 lakh for making the down payment for the house in five years. As evident, these goals are precise, have quantity and a duration. This gives a lot of clarity and therefore, makes it easy to decide what kind of investments should be made for them.
Let's pick two goals for which we will try to build mutual fund portfolios.
Let the two goals be retirement in 20 years (long-term goal) and daughter’s education in 8 years (medium-term goal).
With goals fixed, you need to decide the asset allocation for each.
It's well known that for long-term goals, having a high component of equity is suggested as it helps beat inflation. But equity can be volatile in the short term. And for short-term goals, it's best to have a major component of debt in the portfolio. As for the medium-term goals, a combination of equity and debt can be used.
There can be many asset allocation strategies. But its investor's personal risk appetite that eventually decides the actual tilt between equity and debt percentages.
Assuming that the investor is "moderately aggressive", the following allocations may be suggested:
- Retirement - 70 percent equity and 30 percent debt
- Daughter’s education - 50 percent equity and 50 percent debt
There can be several different allocations depending on various factors. But for simplicity, let's stick to those mentioned above.
So with allocations settled, we need to pick suitable fund categories now.
For retirement (70:30), the natural choice for debt component is EPF, PPF. The remaining can be invested in equity as follows:
- Large cap (index and/or active) - have one or two funds - 30 percent to 50 percent
- Multi cap - have one or two funds - 40 percent to 60 percent
- Mid and small cap - have just one fund - 10 percent to 20 percent
If someone is investing Rs 10,000 per month, then probably one fund in each category is sufficient. But if the investment amount is higher (~Rs 50,000), then having two each of large-cap and multi-cap and one of mid and small cap can be considered. Tax-saving on agenda too? Equity linked savings schemes (ELSS) can replace one of the large or multi-cap funds.
For daughter's education (50:50), a medium-term goal where instruments like PF are unsuitable (due to lock-in), debt funds can be used. In such a scenario, the portfolio might look like this:
- Large and/or multi cap - have one or two funds - 50 percent
- Ultra short/low /short duration - have one fund - 50 percent
As the goal day approaches (the medium-term goal becomes a short-term goal), the equity component must be reduced gradually by systematically shifting into safer debt instruments.
With allocation, categories and number of funds decided, how do you select funds?
Although there are several factors, its best to pick funds that are well proven, come from different and reliable fund houses and have a knack for doing well when compared to benchmark and peer groups. Although it's suggested to not go by past performance alone, sticking with funds delivering consistent returns across market cycles is always better.
Lastly, if you are looking to build a decent and well-diversified portfolio, don't go by the star ratings. They are good to begin with, but you need to dive deeper to finalise the funds. Depending on actual financial goals, building a solid mutual fund portfolio requires some planning. If you can do it yourself, well and good. Else, consider taking help from an investment advisor.Dev Ashish is a SEBI-registered Investment Advisor and founder of StableInvestor.com.