The investment instrument you choose must always be in tandem with your financial objectives. This helps in achieving those objectives in an optimised manner. Mutual funds are a highly versatile set of investment options that help you achieve just about any investment objective. Whether the objective is short, medium or long-term in nature, there is probably a mutual fund for it.
In this article, we’ll take a look at your best mutual fund options. This is more an exercise in understanding what variety of fund to buy rather than which fund to buy.
Broadly speaking, all financial objectives are of three kinds: short term, medium term, and long term. Let’s take a look at the various funds suited for these needs.
Short-term financial goals are typically those that need to be met immediately or within a one-year span. This is a small investment horizon. Therefore, the investment needs to be protected from market risks and offer a conservative rate of growth. Additionally, you need it to be a liquid instrument that can be redeemed at short notice.
Examples: Emergency fund for covering events such as job loss; a holiday fund.
Ideal mutual funds: You may look at short-term debt funds which meet the above-mentioned criteria. You can also look at liquid funds, which not only meet these criteria but also allow redemption without an exit load, which are charged by most funds for redemption before the completion of one year.
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These goals typically have an investment horizon of one to five years. There’s a moderate to high need for your fund to be safe from market risks. But a period of five years is also long enough for you to introduce a degree or risk and increase your returns. Therefore, you need a mutual fund that can keep your capital safe and provide above-average returns. For this you need a mutual fund that mixes equity and debt investments.
Examples: Down payment on property or vehicle, fund for wedding, starting a business.
Ideal mutual funds: You may look at balanced and hybrid mutual funds which invest in both debt and equity as per a fixed ratio. There are debt-oriented funds (that invest 65% or more in debt instruments) as well as equity-oriented funds (65% or more in equity). The further your investment horizon, the higher the risk you can introduce. For example, for a goal two years away, you may invest in monthly income plan fund that invests 10% in equity; for a goal that’s five years away, you can invest in a fund that invests 35% in equity.
These are goals with horizons five or more years away. Since they are so far away, you should ideally take higher degrees of risk and invest in a mix of equity mutual funds. Equity as an asset class can outperform returns from most other avenues in the long run. As per the CRISIL AMFI Equity Fund Performance Index for December 2016, the equity mutual fund category as a whole has returned 10.73% per annum over a ten-year period. This great track record provides long-term investors the hope that investing in equity mutual funds will help them meet their targets in an optimum time-frame and investment costs. Equity mutual funds are also tax-efficient: your returns become tax-free after a period of one year, and your dividends are tax-free up to a limit of Rs 10 lakh in a year.
Examples: Retirement income corpus, child’s education and wedding costs.
Ideal mutual funds: There are a variety of equity mutual fund categories: large-cap, mid-cap, small-cap, ELSS, diversified equity, to name a few. You must invest in a mix of these in a manner that optimises your returns and reduces risks. For example, large-cap funds are considered safer, but small-cap funds may provide higher returns due to higher risks.
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How To Pick A Fund
You must look at various facets of a fund before picking it. These typically include long-term returns, expense ratio, fund manager’s track record, investment portfolio, turnover ratio, and ratings provided by various research organisations. When in doubt, consult a financial advisor.
(The writer is CEO, BankBazaar.com)