Investing in mutual fund
schemes and managing it does not need professional help. Surprisingly, the principles of good investing are simple and easy to follow even by a lay person. We have laid down nine steps which can fix your investment problems and build a winning mutual fund portfolio.
Build a rainy day fund – The investing journey is an exciting one but it needs a solid ground to withstand the shocks and uncertainties of life. The solid ground is built with a very liquid and safely invested rainy day fund of six to twelve months of household expenses. This is the minimum but one can increase it based on individual preferences.
The purpose of a rainy day fund is to meet expenses arising from medical emergencies, job loss, delay in salary payment or other receivables to name a few. Rainy day funds are a buffer during tough times, the key ingredient for financial stability. This fund should be invested in a low risk debt scheme like overnight funds, or in a high yield savings bank account.
Find out your risk appetite - Investments are made to fulfil a purpose, but the journey of investing itself plays a bigger and important role. Investments work well when they reflect our personality and approach to risks. It will be foolish to invest heavily in equities to earn high returns if one cannot bear the sight of a 50% loss.
By knowing your risk appetite, you will set boundaries to investing in risky assets. As the risk appetite grows, through experience and learning, the boundaries will expand as well. The amount of risk one can bear varies individually and can be ascertained by taking incremental exposure to such risky investments.
Online risk appetite calculators are available, but they often mistake better product knowledge with higher risk taking ability. The ideal risk score can only be measured through trial and errors during the investing journey.
Online investing is quick and convenient – A convenient investment is better than a lengthy procedural one. With the advent of the internet, investing in mutual funds has almost become paperless. This has simplified investing to the point where you will never need to interact in-person or go to the fund’s local branch to solve your queries.
Mutual funds, in partnership with banks, have also made the payments process completely digital. This has helped actualise features like systematic investment plans, systematic withdrawal plans which have found many uses. Learning the ropes of online investment will save a lot of time and efforts and redirect focus toward building a better investment portfolio.
Save taxes with ELSS – Proactive tax planning is important in creating an efficient financial portfolio. But, tax saving investments do not need to fetch low returns or be withdrawable only at retirement. Equity-linked savings schemes invests in equities and equity-related instruments, saves taxes and offers the lowest lock-in period of three years.
If invested for long-term and in the right manner, ELSS can help earn higher returns. Investors should inculcate the habit to contribute monthly to an ELSS scheme as a first step into their mutual fund journey. Ensure the contributions to an ELSS are only to the extent of tax deductions allowed.
SIP is the right way – Equity funds have simplified investing in the stock market for the lay investor. But the risks associated with equities have stayed. A popular approach to investing in equity funds is through systematic investment plans (SIPs).
SIPs invest a certain pre-determined amount at a regular interval. This approach reduces the risks associated with investing a large amount at once. SIPs can also be used to invest in debt or liquid funds, as part of one’s investment plan.
Moreover, SIPs create a powerful habit in individuals to invest their monthly savings for long-term goals. Whenever in doubt about equities, use the SIP mode.
Quality over quantity – A quality mutual fund portfolio is one where the number of funds are low, yet adequate. The ideal number of funds one should keep is less than six. This is because having too many funds is difficult to track and manage.
If faced with a new choice of fund, ask yourself whether you really need it. Being thorough with your investments will preserve the quality of your portfolio, which is key to good investing.
The same applies when exiting or replacing any fund. One should not simply exit schemes based on the returns it has generated. Understanding the reason behind poor returns will help take a better and informed decision.
Avoid past return traps – A mutual fund’s performance is often based on its past returns. This is important as it sets expectations of future performance. However, past returns can also turn misleading.
For example, returns of equity-oriented investments are market driven. Therefore, past returns in equities are no guarantee of future performance. It will, then, make no sense to look at past one-year or three-month returns of equity funds to make any informed decision.
Thus, past returns should be read with a pinch of salt. Investors can use this thumb rule - past return period should be proportional with the risks of the product. If it is equity funds, check past five year or ten year returns. If liquid debt funds, check for three-month performance, and so on.
Review and rebalance annually – If you check your mutual fund portfolio returns on a daily basis, it is likely you will take a wrong impulsive decision. Your portfolio should be left alone for long periods and checked only during annual or bi-annual reviews.
The reviewing process should involve checking the returns generated, any underperformance or loss and understand the reason behind it. The review should also involve checking whether the investments are faring in line with expectations, or deviating from the desired goal.
Based on the review, you can exit or increase investments in certain schemes. Investors can also practice tax harvesting to reduce the final tax outgo. Tax harvesting can be done with equity fund units, on capital gains made up to Rs1 lakh in a financial year, which is allowed as tax-free.
Keep it simple – The above steps offer a simple and easy way to build a solid mutual fund portfolio. Revisit these steps whenever you forget it. A simple portfolio also means avoiding any fancy hybrid funds, or sectoral/theme-oriented funds and sticking mainly with the plain, boring pure equity and pure debt funds. A bit of reading on finance and markets is also recommended as it can add a lot of value to your investments.