When it comes to wealth creation, mutual funds have proven to be one of the best diversification tools over the years. However, despite mutual funds yielding high returns, investors are often in a dilemma about which funds to choose, primarily because the market is flooded with options. A number of funds also look similar when it comes to returns, risk, and other parameters.
Hence, the new-age investor tries to create a portfolio of investments instead of investing all the funds in one/two. When it comes to mutual fund investments, a portfolio approach is recommended over buying a single fund too. Today, we will be looking at how you can build a mutual fund portfolio that works for you.
Before zeroing down on the fund, an investor should be thorough with his requirements and expectations. Different instruments serve different purposes. Some provide high returns but are risky propositions, while others may give moderate returns making them more suitable for risk-averse investors. This can be bifurcated into three criteria:
Your goals will determine the composition of your portfolio. For instance, whether you want to save for your child’s marriage, child’s education, retirement planning, generate passive income, wealth creation, etc.
The time horizon will depend on the goals of your investments. If the goal is for retirement planning, then the time horizon will be at least 25-30 years. In such a span, an investor can reap the enormous benefits of compounding. Therefore, an investor should go for a fund that provides better returns in the long run.
Your risk tolerance can entirely change your choice of funds. Your end goals should align with your risk-taking capabilities. If you want 15% returns but aren’t willing to invest in moderate to high-risk funds, then you might end up searching for the ideal fund forever and still not be able to start investing. Returns and risk go hand in hand. Higher the risk, the better the return.
Every type of fund serves a specific goal. Once you know what your goals are, you can make your selection of funds. Selecting the funds might not be as tricky as selecting the AMC.
Different AMCs may provide different returns for the same category of funds. For example, a particular AMC may provide 15% returns for small-cap funds, whereas another AMC may provide 16%-17% returns. It all depends on the companies that the funds are invested in and the fund manager’s expertise. The same applies to risk-taking as well. Therefore, make a comparison and select the best to invest.
The expense ratio is the amount of expenditure incurred to manage the fund. It comprises the administration and operating expenses of the fund. The lower the expense ratio, the higher the returns available for an investor. In the long run, the difference that the expense ratio can create can run into lakhs because of the compounding effect.
Investments can be done in either of the two ways:
Here, a lumpsum amount is invested in the fund at a single point in time. This method can be used to park excess funds available with the investor or as a tax planning tool near the close of the financial year.
SIP is a facility where an investor can invest a fixed amount regularly over a period of time. SIPs can start at as low as Rs. 100. The SIP date and duration are at the discretion of the investor. The benefit that SIPs provide is that if the market falls, an investor can purchase more units for the same SIP amount, and if the market rises, then the value of the portfolio of the investor increases. In any case, SIP benefits the investor.
SIPs are of two types:
Using this framework, you should be able to create a portfolio of mutual funds that work towards achieving your financial goals. While there are many other aspects to building a perfect one, this should get you started.