How to build your mutual fund portfolio from scratch

Suppose you want to save for three major goals: i) Down payment for the house purchase in four years’ time; ii) Daughter’s higher education in 7 years, and finally iii) Own retirement in 20 years.

Saving for different goals

You did some number crunching to find out what is the right amount to invest for different goals based on proper asset allocations rules. So it might seem something like this:

-For House down payment in 4 years - Rs 25,000 per month at 100 percent Debt: 0 percent Equity

-For Daughter’s Higher Education in 7 years - Rs 20,000 per month at 50 percent Debt: 50 percent Equity

-For Retirement in about 20 years - Rs 30,000 per month at 70 percent Equity: 30 percent Debt

I am sure you know what the above allocations are suggested. For long-term goals, a larger equity component is advised as it helps generate inflation-beating returns. But in the short-term, equity can be quite volatile and hence, short-term goals are best handled by debt in the portfolio. And what about medium-term goals? A simple combination of equity and debt can be used for such goals.

So now you know the precise amounts and how much of that is to be distributed between equity and debt. Now comes the question, as to how to build a solid mutual fund portfolio around this.

Let’s pick one goal at a time.

House Down payment goal (4 years)

This is a short-term goal and hence managed purely (or preliminary) via debt instruments. So choosing 1 one fund from the below category options should serve this goal’s requirements:

- Low / Short Duration / Conservative Hybrid fund (1 fund) - 100 percent

Daughter’s Higher Education Goal (7 years)

This is a medium-term goal. So a combination of debt and equity can be used. I have suggested 50:50 but one can even have 60-65 percent in equity initially if one’s risk appetite is suitable.

For such a requirement, the MF selection can be as follows:

- Large Cap Fund / Flexicap fund (pick 1 fund) - 50 to 60 percent

- Low / Short Duration fund (1 fund) - 40 to 50 percent

Or if you want, you can simply take the below one fund option:

- Aggressive Hybrid Fund / Dynamic Allocation Fund (1 fund) - 100 percent

After a few years, when this medium-term goal starts becoming a short-term goal, you will then have to consider gradually reducing the equity component to reduce the risk of getting poor (negative) returns near the goal day.

Retirement Goal (15-20 years)

This is a critical long-term goal. First, for the debt side of the portfolio, best to maximize your EPF and PPF. If that is not sufficient, consider increasing EPF via the VPF route. Or you can also look at using NPS as a debt tool with proper allocation in schemes G and C.

With respect to equity, for which about 70 percent allocation is suggested, you can opt for the following:

- Large Cap Index funds (1-2 funds) - 30 percent to 50 percent

- Flexicap fund (1 fund) - 20 to 30 percent

- Large & Midcap fund / Midcap fund (1 fund) - 20 percent to 30 percent

- International fund (1 fund) - 10 percent to 20 percent

So that is how you build your mutual fund portfolio that takes care of different goals and provides proper diversification across assets, fund categories, and investment styles.

Note: If there is a need for a tax-saving fund, then one can replace Large-cap or flexicap funds in the above goal portfolios with an ELSS fund (which primarily takes a large-cap or flexicap approach).