Building Mutual Fund Portfolios

Mutual Funds are the best option to build a well-rounded portfolio of stocks, bonds and alternative investments. As there is no single investment which can be called the best at managing every asset class, a diversified approach is an ideal way to go forward. Building a mutual fund portfolio is as important as building a home and needs a lot of patience. This involves knowing your financial capacity, personal tastes and preferences; and care

So what should one do?

Clarity
Decide on your financial objectives and the risk you are willing to take to achieve those objectives. For example your goals could be paying a personal loan, providing for children’s higher education, a foreign trip, daughter’s marriage and your retirement corpus at various points in time. The goals must be realistic and in line with your financial position and risk appetite.

Give time
Once you know where you stand and where you want to go, the rest is just a matter of details. Match each goal with the appropriate MF category. Equity markets are too volatile in the short-term, but can give good returns in the long run. Debt funds, on the other hand, give steady but low returns. Therefore, select the goals, which you will finance through equity funds and through debt funds.
If your retirement is still 15 years away, a predominantly equity portfolio may be a better option. But for your personal loan, which is payable just one year hence, debt funds will be more suitable. And for the medium term, like your foreign trip, balanced funds may be the right answer. Liquid funds are a nice way to park your very short-term funds.

Avoid concentration and over-diversification
Depending on the corpus, one could invest in an average of 4-7 funds for an equity portfolio and maybe 3-4 funds for the debt and balanced category. Too less a number of funds make your portfolio concentrated and risky. Too many, makes it unmanageable and doesn’t really serve the purpose. You need to strike the right balance. Also, while selecting the fund, study their portfolio mix and ensure that they are different. If most of them are same, then even with 6-7 funds you won’t get the desired diversification.

Have a suitable mix
Apart from allocating your corpus in different asset classes, you need to do some allocation within the equity class. Index/Large Cap funds, Mid-cap/Small cap funds and Sector Funds are the 3 broad sub-categories in which you have to divide your corpus. Index and Large Cap funds will deliver steady returns, which will be in line with the market performance. In the equity space, they carry lesser risk as compared to mid-caps, small caps etc. Go for funds with moderate risk and consistent performance.

The tax aspect
Neglecting to pay tax is bad, but tax planning is not. It can help you to minimize your tax outgo, legally. Therefore, take care to choose the right option – dividend payout, dividend reinvestment or growth. They may help you to save unnecessary taxes. Make sure that you use the post-tax returns in your calculations. Else you may miss your target.

Conclusion
Having built a suitable portfolio, you need to nurture it. You have to regularly feed it with additional investments. You will have to remove the weeds (poor performing funds) periodically. And be patient. It takes time for the tree to grow. But once is has grown, it becomes strong – so you don’t have to take too much care; and fruitful – it will give you returns year after year.

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