By Shruti Jain
When we like most things in our lives custom-made, why should our mutual fund portfolio be any different? Whether it is your suit, house, interiors or mutual fund portfolio – a tailor-made approach is the best fit and gives the best results too! Picking random best-performing funds based on a Google search or investing in funds based on ‘expert recommendations’ may seem like a smart option. But this approach is same as buying a good-looking suit off-the-rack from the store. It looks stylish on the mannequin, but when you try it on it’s ill-fitted and drags down your personality.
What you need is a mutual fund portfolio that’s truly yours. This means hand-picking funds to make a portfolio that can outperform the index, while also being in sync with your personal risk tolerance, investment objectives and tax situation. While there is no one “correct way” to build a mutual fund portfolio there are some universals you should think about when choosing and combining funds to create your portfolio.
Know your risk tolerance and investment horizon
Before choosing your funds, you need to first figure out the time period for which you expect to hold your investments, i.e., your investment horizon. When you kickstart your investment journey you should know for which financial goals are you investing. Your portfolio should include funds that are suitable for your short-term goals (less than 2 years) like a vacation or renovating your house, mid-term goals (2-8 years) like buying a car, and long-term goals (over 8 years) like buying a house, retirement, or child’s education.
Next step is determining how much risk you can tolerate. When it comes to money, you need to really be honest with yourself. Being too cautious, than you really are, or thinking you can handle high levels of risk because you love bungee jumping can be painful later.
Determine your asset allocation
The foundation of your portfolio is asset allocation— your preferred combination of large-cap, mid-cap and small-cap Indian funds, international funds, debt funds, money market funds and gold funds. It determines the broad risk level of your portfolio, which should match your risk profile, and is the first step towards constructing a diversified portfolio. Diversification works because different asset classes, sectors and securities don’t move in tandem.
Different factors determine the appropriate mix for you, how much exposure you should have to any asset class, and what the time horizon should be for your investment.
Equity markets are too volatile in the short-term but have been regarded as the best-performing asset class in the long run. Debt funds, on the other hand, give steady but low returns. Depending on your goal and risk profile, the asset class will be determined. If, say, your retirement is 15 years away, an equity-dominated portfolio would be a good option. But if you have taken a personal loan that needs to be paid in just one year, debt funds will be more suitable. If you have a medium-term goal, like a trip abroad, balanced funds may be the right answer. And generally, liquid funds are a nice place to park very short-term funds.
The rest of the investment process includes picking funds—either for taxable or tax-advantaged accounts— putting them together in a portfolio, monitoring the portfolio over time, and rebalancing it so it remains in line with your risk tolerance.
Pick the right Funds
When you put together a portfolio of mutual funds, your goal should be to outperform the relevant benchmarks for each asset class in your portfolio.
Getting the right number of funds in your portfolio is important to strike the right balance. If you invest in too few funds, it could make your portfolio concentrated and risky. If you invest in too many, the portfolio becomes unmanageable and doesn’t really serve the purpose. Also, while selecting funds, study each one’s portfolio mix to ensure that the funds are not all similar, otherwise, you will not achieve the desired diversification.
Depending on your investment amount, you could invest in an average of 6-7 funds for an equity portfolio, and 2-3 funds for other categories like debt, balanced or gold. Of course, the mix will vary depending on your risk tolerance and investment horizon.
Getting to the fund selection. You should consider the following factors when picking the right funds: past performance, including past risk- and style-adjusted performance (a measure of the fund manager’s security selection skill), the fund’s operating expense ratio, assets under management, and cash flows.
Use a blend of quantitative and qualitative analysis. The first thing to remember in evaluating a mutual fund scheme’s performance is to separate performance luck from skill. You should see the fund’s year-on-year performance to see if it has been doing consistently well, or if this is just a one-time good performance which has boosted returns.
While numbers are important, qualitative considerations matter too. Look at the fund manager’s profile, the performance of his/her other funds, and his/her investment strategy. For instance, it could happen that the fund is categorised as a low-risk investment, but the fund manager is actually taking an aggressive stance.
Once you have selected your funds, decide how much money you want to invest right away (lump-sum) and how much would you like to invest monthly using a systematic investment plan (SIP).
Rebalancing and Monitoring
Portfolio management doesn’t stop with the creation of your portfolio. It’s important to monitor funds on an ongoing basis. Just as a disciplined diet and an exercise routine are critical to your physical health, a disciplined rebalancing strategy is critical to your financial well-being.
Rebalancing back to your target allocation at least bi-annually is important. You may want to rebalance sooner if there is an extreme change in value in some part of your portfolio or a change in your life circumstances.
A periodic review helps identify a consistently poor performer and take corrective action, if necessary. You should consider selling a fund if there is a change in management, organisation, or strategy, or if you foresee a significant deterioration in the fund’s prospects.
The last leg
Now that your custom-made mutual fund portfolio is ready, do not look at your portfolio performance every day. And you shouldn’t expect it to deliver returns every day, week or month. If you have diversified your holdings and chosen well, your portfolio will steadily gain value over time.
(The author is Chief Strategy Officer at Arihant Capital Markets Limited.)
(Disclaimer: Views expressed above are those of the author and do not reflect the views of financialexpress.com. Mutual fund investments are subject to market risks. Please consult your financial advisor before making any investment decision)