Good asset allocation while investing in mutual funds

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What are the important things to keep in mind when choosing a mutual fund portfolio?

-B Hanmatha Rao, Medchal

Mutual funds offer investment solutions for various investment needs for investors of all ages and people from all walks of life. The selection of mutual funds depends on several parameters. The investment objective and the socio-demographic variables of the investor, such as age, employment status, marital status and dependents, are at the forefront.

The next essential parameters are the investor’s risk tolerance, income, savings, return expectations and investment horizon. Another essential parameter is the investment goals of investors, including various life goals of investors, such as higher education of children, planning vacations, buying a car, buying a property and retirement planning. Based on the investor’s information, financial advisors or mutual fund brokers would recommend which mutual funds to invest in.

One should also scrutinize the track record of the fund, the experience and competitiveness of the fund managers and the credibility of the Asset Management Company (AMC). Investors can obtain this information in the Mutual Funds’ Key Information Memorandum and Factsheets. Make a plan and tell your advisor how much and for how long you want to invest. They will tell you where to put your money. Financial advisors or mutual fund dealers construct a portfolio of mutual funds based on the risk appetite of investors.

Liquid funds would be better for investors with a short-term horizon. Those who want to park a lump sum for a month or less than three months. Investors with a long-term horizon and an appetite for risk can invest in equity mutual funds and balanced funds to build a retirement corpus over a long period of time. Equity funds are suitable for aggressive long-term investors.

Equity funds are the ideal choice for investors seeking long-term capital appreciation. Equity mutual funds are the best choice for aggressive investors with a higher appetite for risk. Because these funds are associated with risk, returns from equity mutual funds can be higher than those from all other types of mutual funds.

Flexi-cap funds and large cap funds are best suited for investors wishing to build wealth over a long period of time. Flexi-cap funds, in particular, invest across sectors based on the fund managers’ outlook. ELSS (Equity Linked Savings Scheme) is ideal for investors who want to claim a tax refund of up to Rs 1.5 lakh per annum. With the exception of ELSS, investments in other types of mutual funds are not eligible for tax benefits under Section 80C income tax.

MIPs (Monthly Income Plans) and income funds would be ideal for investors whose goal is to generate regular income. Debt funds are a safe bet for investors looking for regular income and those with a low appetite for risk. Investors with a short or medium term horizon can also choose debt funds. Mutual funds generate lower returns than stock funds.

However, investors should exercise caution when investing in mutual funds. Past performance is a strategy that can backfire. Like stocks, mutual funds also do not generate stable returns and no fund can consistently deliver high returns. Some fund regimes may provide continuous returns for a decade, while other fund regimes may provide steady returns for a few years, followed by excellent or catastrophic returns over the next few years.

Risk appetite refers to the maximum risk an investor is willing to take to achieve their goals before the risk outweighs the rewards. Simply put, an unfavorable financial outcome relative to investors’ expectations is a risk. Based on risk appetite, there are three types of investors: conservative investors, moderate investors, and aggressive investors.

Some investors are conservative and cannot take risks. Some investors may have a moderate risk capacity, and some investors may have a higher risk appetite than others. If an investor plans to stay invested for the long term, their risk appetite should be moderate or high. People with a low horizon mostly have a low tolerance for risk.

Risk capacity or risk appetite is mainly based on age, gender, life stage, financial status, dependent children and parents. Proper asset allocation while investing in mutual funds will balance risk and return, as these two variables are directly related. Evaluate these factors and make informed investment decisions before investing in the best mutual funds.

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