Mutual fund categories are basically a way of differentiating mutual funds on the basis of  risk and returns.

This gives an idea to investors about the types of instruments in which their money is invested.

Under specific categories, there are various mutual fund schemes that have the same portfolio structure with stocks or instruments of different companies.

So, a fund under the equity category may invest a maximum percentage of their funds in equities or equity-related schemes of different companies.

Therefore, we can say that fund category is a broader term which consists of various mutual fund schemes.

Every individual has different financial goals, risk appetite, duration of investment and so on. All these factors differentiate one investor from the other.

Being an investor, you must be aware of certain things before you start investing in a mutual fund.

Still, there might be some questions in the back of your head.

How to choose the fund to invest in? Should I choose the fund as per my risk profile or the fund with higher returns?

Without a second thought, the choice of fund should be as per your risk profile.

Choosing the right category is the first the first step to a successful investment.

Every investor should invest in the vicinity of their risk profile and financial goals. Your choice must never wholly depend on the returns provided by the fund.

Moreover, your choice should be the fund with the highest return in the right category.

If you are still not satisfied, then let’s understand the importance of proper asset allocation in your portfolio.

Each category has different risks, returns and an ideal duration for investment.

Can mutual funds help in diversification?

Mutual funds are broadly classified into various categories like equity, debt, hybrid and cash.

For example, in an equity fund category, the fund manager will diversify assets in such a way that a large part of the asset will be invested in equity and equity related instruments with a small fraction of investment in debt funds or cash.

Similarly, in the debt fund category, majority of the funds will be allocated among debt instruments.

This is the reason whyu each mutual fund has different risks and returns.

So, before investing in the mutual fund you must understand your risk profile and accordingly choose the right category of mutual fund.

Importance of asset allocation

Now, let’s see why exactly asset allocation is important for every portfolio.

1.Protection from market volatility

A balance in every aspect is very important.

If your portfolio is diversified in a proper manner, your money will be protected from market volatility.

For example, you have a proper asset allocation, that is, your portfolio consists of equity, debt and hybrid instruments.

Now, during the down fall of the market, the debt and hybrid securities act as a cushion and protect your portfolio from adverse situations.

Also Read: Is it wise to time the market?

2.  Lower investment risk

A diversified portfolio will lower your investment risk, because the growth prospects are not limited to one risky security.

Rather a proper asset allocation will help you create a basket of both risky and non-risky securities, across equity and debt, which will minimize the risk of uncertainty.

3.Optimizing returns

Many times investors are either too aggressive or too conservative.

This reduces the chances to earn a consistent and good return.Just setting up goals is not enough for investing.

You should have a proper viable plan and have to choose the investments accordingly. This will help you meet your goals easily and optimize your returns.

4. Freedom from timing the market

Many individuals feel that investing is a hard and stressful thing.

But let me tell you, if done strategically and systematically, it is the easiest possible way to grow your money.

Most of you who try to actively time the equity market can testify to its volatility.

Now, consider timing the performance and market movement across different asset classes. This removes the problem of timing the market and makes investment an easy task.

Also Read: Mutual Funds: Things you should know as a beginner

Implementation of asset allocation

Even before you start investing, you have to decide the asset allocation of your portfolio.

You can do this by assessing your financial goals, amount of investment, etc.

For example, if an investor with a moderate risk profile wants to invest Rs. 10 lakhs, He can allocate 50% to equity mutual funds, 45% to debt mutual funds and 5% to cash.

Now, this is supposed to be monitored on a regular basis.

So, after a year, if due to a rise in the stock markets, the equity mutual fund allocation rises to 60%, then it should be brought back to its original level of 50%.

Similarly, if additional money needs to be allocated to this portfolio, it should follow the same principle.

Further, you can change the asset allocation of your portfolio as and when the market changes.

When the market is down, it’s beneficial to divert most of your investments towards debt instruments as these are relatively stable and remain less affected by market volatility.

On the other hand, when the market is on a high, you can increase the allocation of equity to capitalize most of the market.

Hence, it is important to allocate the assets properly and review the same on a constant basis to keep the portfolio in sync with the market conditions.

Conclusion

So investors, you now know the necessity of smart allocation of funds and the process to have a balanced portfolio.

Thus, start planning your investments accordingly and if already invested, do review, rebalance and reallocate your asset categories.

Happy Investing!

Disclaimer: The views expressed in this post are that of the author and not Groww