Proper asset allocation while investing in mutual funds

Which are the important points to keep in mind while 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 handpicking of mutual funds depends on multiple parameters. The first and foremost things are the investment objective and the socio-demographic variables of the investor, such as age, employment status, marital status, and dependents.

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

One must also scrutinise the track record of the fund scheme, the experience and competitiveness of fund managers and the credibility of the Asset Management Company (AMC). Investors can obtain the information from the Key Information Memorandum and Factsheets of the mutual fund schemes. Chalk out 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 brokers build a mutual fund portfolio basis the investors' risk appetite.

Liquid Funds would be best to invest for investors with a short-term horizon. Those who want to park a lump sum amount for a month or less than three months. Investors with long-term horizon and risk appetite may invest in Equity Mutual Funds and Balanced Funds to build a corpus for retirement over a long period. Equity funds are suitable for aggressive long-term investors.

Equity funds are the perfect choice for investors looking for capital appreciation in the long term. Equity mutual funds are the best choice for aggressive investors with a higher risk appetite. Since these funds are associated with risk, the returns from equity mutual funds schemes can be higher than all other types of mutual funds.

Flexi-cap funds and large-cap funds are best suited for investors wanting to create wealth over a long period. Flexi-cap funds, especially, invest across sectors based on the outlook of the fund managers. ELSS (Equity Linked Savings Scheme) is ideal for investors who want to claim a tax rebate of up to Rs 1.5 lakh a year. Except for ELSS, investments in other types of mutual funds are not eligible for tax benefits under Section 80C of 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 seeking regular income and those with a low-risk appetite. Investors with a short to medium-term horizon may also choose debt funds. Debt mutual funds generate lower returns than equity funds.

However, investors must exercise caution while investing in mutual funds. Past performance is a strategy that can backfire. Like equity stocks, mutual funds also do not generate stable returns and also no fund can consistently provide high returns. Some fund schemes may offer continuous returns for a decade, while others fund schemes may give steady returns for a couple of years, followed by excellent or abysmal returns in the next few years.

Risk appetite refers to the maximum risk an investor is ready to take to further his objectives before the risk outweighs the benefits. Simply put, an adverse financial outcome against investors' expectations is a risk. Based on risk appetite, there are three kinds of investors – conservative investors, moderate investors, and aggressive investors.

Some investors are conservative and cannot take risks. Some investors may have a moderate risk-taking capacity, and some investors may possess a higher risk appetite to take risks than others. If an investor plans to stay invested for the long-term route, then his/her risk appetite would need to be moderate or high. People with a low horizon mostly have a low-risk tolerance.

Risk capacity or risk appetite is predominantly based on age, sex, stage of life, financial situation, 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.