How to make most of your investment portfolio

An efficient financial planning should always aim at generating optimum returns from an investment portfolio. However, making wrong investment choices or ignoring important investment fundamentals can create major gaps in your investment portfolio, which can adversely impact your portfolio returns over the long term. Here I will suggest some tips for fixing the gaps in your investment portfolio for generating optimum returns.

Invest in equities to achieve long term financial goals

Many investors fail to appreciate the impact of inflation on their investment portfolios and financial goals. As inflation reduces the purchasing power of money, inflation rates exceeding the returns from the investments would land one with inadequate financial corpuses for achieving his future financial goals. Note that fixed deposits and other fixed income instruments barely beat the inflation rates while equities as an asset class beats inflation rates as well fixed income investments by a wide margin over the long term. Thus, investors should invest in equities and equity oriented mutual funds to achieve their long term financial goals. They should invest in fixed deposits or other fixed income instruments for achieving their short term financial goals as equities can be very volatile in the short term.

Shift to growth option from dividend option in mutual funds

Many investors opt for dividend plans while investing in mutual funds as they wrongly consider mutual fund dividends to be a windfall income. However, the dividends declared by mutual funds are paid from the funds’ own AUM. As a result, the NAV of the dividend declaring mutual fund is also reduced by the value of dividend paid out on the dividend record date. Moreover, the dividend amount is calculated as a percentage on the funds’ face value and not on the basis of its NAV. Opting for the dividend plan is also tax inefficient as the mutual fund dividend receipts are taxed as per the tax slabs of the investors. Thus, mutual fund investors should opt for the growth option to reduce their tax liability while making the most from the power of compounding.

Shift to direct plans from regular plans

Direct plans of mutual fund schemes have lower expense ratios, usually up to 1 per cent lower, than their regular counterparts. Expense ratio refers to the per unit cost incurred for managing a mutual fund scheme. Apart from the fund’s administration expenses, management expenses, etc, the commission paid to its distributors is also factored in while calculating the expense ratio. As investors can directly invest in direct plans without the involvement of the fund distributors, the savings made in the distributor commission is passed to the investor in the form of lower expense ratio. As the savings made in the distribution expenses remain invested in the direct plans, the savings itself start generating returns on their own. This allows direct plans of mutual fund schemes to generate higher returns than their regular plans. Although the outperformance in returns might seem trivial in the initial years, it can become significant over the long term due to the power of compounding. Thus, consumers invested in regular plans of mutual funds for their long term financial goals should shift to their direct counterparts to build bigger corpuses.

Invest in ELSS to save tax under Section 80C

Equity Linked Savings Schemes (ELSS) are diversified equity mutual funds, whose investment contribution qualify for tax deduction under Section 80C. These schemes have a lock-in period of three years, which is one of the shortest amongst all investment instruments eligible for Section 80C deduction. As ELSS funds invest primarily in equities, the returns generated by these schemes outperform the Section 80C eligible fixed income instruments as well as the inflation rates by a wide margin over the long-term. This makes ELSS an excellent tax saving instrument for achieving long term financial goals.

Review your portfolio at regular intervals

Periodical review of one’s mutual fund portfolio is as important as regular investing. Even funds having consistent track record of outperformance over their peer funds and benchmark indices can become long term laggards due to the changes in market conditions or fund management style. Thus, funds consistently underperforming their benchmark indices and peer funds for 3-4 consecutive quarters can be considered as under-performing ones and can be redeemed for better performing ones.

Investors should also identify the changes in their risk appetite, financial goals, funds’ fundamental attributes and macro-economic factors. This would allow them to make necessary adjustments in their portfolio for deriving optimal asset and security mixes.

Maintain an adequate emergency fund

The main purpose for maintaining an emergency fund is to cover your unavoidable expenses for at least six months in the event of loss of income caused by unemployment, ailments or other unforeseen events. Without an adequate emergency fund in place, one might be forced to redeem his investments earmarked for crucial financial goals or avail loans at high interest rates to deal with financial exigencies.

The author is Co-Founder & CEO of Paisa bazaar