There are broadly two ways to make the recipe for a successful mutual fund portfolio. One is where you can customize as per your preference, your goal, your risk appetite, how much time you want to invest, etc. The other way is to choose a readymade diversified Fund of Funds that selects other funds to invest your money in depending on the market conditions.
DIY recipe for building your mutual fund portfolio
With the plethora of mutual fund options (over 2500+) out there, how do you weigh the pros and cons before making your choice?
Step 1: Start with a goal
This is the first step towards building a robust portfolio. Envision where you want your financial investment to take you. It may be to achieve your dream home, your child’s education, your child’s marriage or your dream retirement. Then allot a number to your goal depending on your income and expenses.
Step 2: The Right Asset Mix
As the adage goes, ‘Do not put all your eggs in one basket’, do not solely rely on one asset class to achieve your envisioned goal. Every asset class plays a pivotal role in the portfolio.
Have the right balance of all the asset classes from equity to bonds, gold, cash, that will diversify your portfolio and help to earn the total return over time to achieve your goal. The balance of risk and reward acts as a guiding principle in determining the right asset mix of an investment portfolio. For example, in March 2020, an investor who was heavily invested in equities could have had suffered losses on redemption. On the other hand, an investor, who would have not invest invested in equities after March during the rally that followed would have again missed out on growing his investment. Therefore, it becomes important to have a diversified asset mix. The presence of other asset classes such as gold could have mitigated his downside risk.
Step 3: Risk Profiling
Every single person has a different risk profile and it depends on the investors age, income, expenses, loss bearing capacity. The percentage of your portfolio you devote to each asset class depends on your risk appetite, risk capacity and risk tolerance.
Step 4: Proportion matters
The old thumb rule of subtracting your age from 100 works fine in most cases. Subtract your age from 100 to arrive at the ideal asset allocation for your investments. So if you are 25, you need to dedicate 75% of your investment to equities whereas the rest 25% can be to bonds and gold.
On the other hand, an investor aged 60 years needs to invest 40% in equities and 60% in fixed income investments and risk reducing assets like gold.
Step 5: Filter the right mutual funds
It becomes challenging to choose which is the right mutual fund for you.
As with all investments, it’s important to research the mutual funds past results. Here are top 5 questions that you could should ask yourself while reviewing the mutual fund performance:
- How does the fund perform across timeframes? Just evaluating past one year is not enough, dig deeper to find out the fund performance across 3 year & 5 years’ time period.
- How does the fund compare across market cycles and in comparison to benchmark index and peers?
- Who manages the fund? The success of a mutual fund depends on the fund manager’s skill at choosing the right investments to enable you to get the most of the market cycles. Does the manager run other funds? If yes, then how successful have they been?
- Does it deliver risk adjusted return? A Sharpe ratio might be a good assessing point in evaluating whether the fund delivers risk adjusted returns. The Sharpe ratio measures the additional return an investor gets for the additional risk he/she takes. A higher ratio represents higher returns for every unit of risk.
Multi Asset Fund of Funds
There exist funds which invest in other mutual funds, think of this as your readymade fund portfolio that invests in various kinds of mutual funds in the market.
Such funds offer a significantly higher degree of diversification. It offers downside risk protection and the mutual fund selection then rests on the fund house that selects funds depending on relative macro and micro market trends, fund performance across timeframes and market cycles and fund manager’s competence. It offers a one-stop solution for investing in Equities, Debt & Gold. Multi Asset Fund of Funds also offers periodic re-balancing between asset classes depending on the market conditions.
In conclusion, those investors who wish to invest in multiple mutual fund schemes and do not have the time or bandwidth to research they can consider a Fund of Funds, whereas those who prefer greater hands-on approach can look at DIY asset allocation. You can also look at a combination of Multi Asset FoFs and Mutual Funds that offer diversification and help realize your goals.
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Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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