Strategic investments in mutual funds can help build retirement corpus, make down payment on your home loan and finance your child’s education expenses.
For most of us, the three primary milestones in life are arranging a down payment for the home loan, creating a corpus for kids’ needs such as education and marriage and lastly, accumulating funds for one’s own retirement. Proper assessment of each of these goals after they are identified, estimated for their inflation-adjusted worth and then finding the right asset mix based on one’s risk profile marks the steps towards achieving them with ease.
Meeting these goals requires a judicious mix of various asset classes but the reliance on equities should be at the forefront, especially when the goal is at least seven years away. As a retail investor, it’s better to stick to equity mutual funds to realise the true potential of equities. Several studies have shown that equity has the potential to generate high inflation-adjusted returns over the long term, among all asset classes. Debt, as an asset class, has its own role to play in helping achieve the goals. Volatility in debt is less, therefore invest in debt mutual funds to meet goals that are between one and three years away or during the de-risking process when a goal nears. For goals that are around five years, balanced funds that have a mix of equity and debt assets come handy. Ideally, to save for any goal make use of the systematic investment planning approach as it helps to keep costs lower and instills discipline in savings.
Now, let us see how each of the above goals can be met through mutual funds.
Owning a home
Owning a home requires a sizeable amount of funds and nearly 20% of the cost of a home is to be arranged as down payment for a home loan. The more the better as it keeps the interest burden in check. If the time horizon is less than three years, the reason to take more risk may not be there as equities need longer time-frame to perform. So, it is better to save through debt funds. When time horizon is close to five years, balanced funds suit this situation. Balanced or hybrid funds, as the name suggests, allocate assets in their portfolio to both equity and debt, most of them with a bias towards equities.
As the goal nears, start shifting to less volatile debt funds. In case there is a gap in funding, opt for loans against existing assets like bank fixed deposits. If shortfall still persists, liquidate investments especially those generating lower than inflation returns and not nearing its maturity.
Meeting needs of children
When it comes to taking the mutual fund route to plan for your kid’s future, get a fix on your target amount and then work backward to ascertain how much money you need to put aside every month. If your child needs the funds anytime more than seven years from now, opt for equity funds.
Stick to large-cap funds as they invest in well-established, top-rung companies and are, therefore, less volatile. Mid-cap funds can be considered to get the kicker in returns. The idea is to take the equity advantage and yet control the risks you take. Opt for consistently performing equity schemes with an established track record. Put any windfalls like bonuses, arrears into existing investments.
Nearing goal, ensure you gradually shift funds towards debt funds to preserve the accumulated corpus. One can also make use of systematic withdrawal plan (SWP) to shift funds from equity to debt funds on regular intervals.
Once you start accumulating your retirement funds, you want your money to work harder for you. Invest in instruments where the compounding takes place more frequently. Re-adjust your risk profile gradually to increase returns. Asset allocation depends largely on the level of risk you are comfortable with.
When you are young, with more disposable income and fewer liabilities, you are more likely to take risks. Invest around 75% in equities if you are an aggressive investor, if you are the conservative type, a 65% allocation is a good idea. If you are in your thirties, lighten up on your equity funds holding marginally, the aggressive investor from 75% to 65%, and the conservative investor from 65% to 40%. In the forties and beyond, stick to the asset mix going along. The right mix of assets goes a long way in determining how much you end up having at the end of the goal.
(The writer is senior VP & group head, Marketing, Bajaj Capital)