Which mutual fund categories to invest in when retirement is 20 years away?

If you are a conservative investor, then you should stick to large-cap funds. That too, passive large-cap index funds and not active large-cap funds. The reason is that nowadays most active large-cap funds find it hard to beat index returns.

Since one can’t keep churning one’s portfolio every year running after the best fund, it’s better to skip active large-caps altogether and have your core equity allocation in large-cap index funds (or ETFs). Having just one or two Nifty50 or Sensex index funds is sufficient. You don’t need to invest in other equity fund categories at all.

If you are a balanced investor, then you can have schemes from categories like large-cap funds, flexi-cap funds, large & and mid-cap funds. For large-cap funds, go for Nifty50 index funds. Since funds within the flexi-cap and large and mid-cap categories have different investment strategies, one can have more than one scheme from these categories in their portfolio. A suggested approach is an equity allocation 40-50 percent in Nifty50 index funds, and the remaining 50-60 percent in flexi-cap, and Large& mid-cap funds.

If you are an aggressive investor, then you will anyways have a higher equity allocation. So, in addition to above-suggested fund categories like Nifty50, flexi-cap, and / Large& mid-cap funds, you can also have some allocation towards standalone midcap and small-cap funds.

For the aggressive investor, a suggested approach is 30 percent allocation in Nifty50 + Nifty Next50 index funds, 30-40 percent in flexi-cap funds, and 30-40 percent in mid-cap + small-cap funds.

Most investors don’t need mid-cap or small-cap funds as any such exposure is sufficiently provided by flexi-cap funds. But given the high-return potential of these funds in the long term, and assuming the investor is mature enough to digest the ensuing volatility, aggressive investors can have about 30 percent exposure in these fund categories as suggested above.

As you can see, unless you’re a conservative investor, its best to have a mix of active and passive mutual funds.

If you are a new mutual fund investor who wants to start investing for his retirement, start with large-cap and flexi-cap funds. If you need to save taxes as well, go for ELSS funds with high large-cap allocation (check market-cap allocation using the tool here). Once you understand how equities work and have gained a few years of experience, you can add mid-cap and small-cap funds to the mix as well.

Solution Oriented funds

Solution Oriented funds are a separate category of mutual funds introduced by SEBI. It is meant to cater to financial planning goals like retirement. The managers of these funds are free to pick a strategy depending on the investor’s age. The schemes have a lock-in period of five years.

While the intent behind this category is fine, you don’t need them. Also, given the lock-in, what if the solution oriented fund you choose underperforms? You will not be able to switch to other funds until the expiry of the lock-in period. Best to avoid this category altogether and stick to the abovementioned open-ended funds. They do a good enough job.

Don’t have a buy-&-forget approach

Once you have started investing in equity funds for retirement, you still have to make sure that you regularly review your portfolio. While index funds demand lesser attention, active fund categories like flexi-cap, mid-cap, etc. need regular review. If the chosen funds are not doing well for extended periods (like 1-2 years), then you should replace them. Therefore, make sure you review your retirement portfolio at least once a year

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