Invested in all ‘top-performing funds’ and yet not able to achieve your financial goals? Or do you have 10-15 mutual funds in your portfolio? Then, this post is for you. In this blog, we will go through a detailed and systematic 5-step process on how you can build a mutual fund portfolio that can help you reach your financial goals.
But, before we answer that question, let’s first understand the 5 different types of mutual fund schemes as per the official SEBI categorisation. Knowing this in detail will help us in selecting the appropriate schemes which are in line with our overall goals.
5 types of mutual funds (official SEBI categorisation):
- Equity schemes: An equity scheme is a fund that primarily invests in equity or equity-related instruments.
- Debt schemes: A debt scheme primarily invests in fixed-income instruments like bonds, commercial papers, and certificates of deposits issued by the government or corporate
- Hybrid schemes: Hybrid schemes invest in a mix of debt and equity instruments
- Solution-oriented schemes: Solution-oriented schemes are targeted towards a particular goal like children’s education or retirement with a statutory lock-in of 5 years
- Other schemes: These primarily include investments in index funds and fund of funds (Fofs) that invest internationally.
All the different funds offered by mutual fund companies fit into one of the above categories. If you see categories like ‘Liquid’ or ‘Money Market’ in various websites or news then please know that those officially come under the ‘Debt schemes’ category. It is not a separate category by itself. To keep things simple for this post, we will not delve into the various sub-schemes under the above categories. You can visit the official documentation to learn more about it.
Ok, now that we know what different categories of mutual fund schemes are, let’s see how we can make use of that information to create a mutual fund portfolio.
How to create a mutual fund portfolio (with example):
Step 1: Assess your risk tolerance and time horizon:
It is often seen that most investors invest randomly without ascertaining both these attributes. Assessing your risk level and time horizon for investing is a prerequisite for creating a good mutual fund portfolio. To assess the former, you can make use of the various free tools available online. For e.g. Let’s say that your risk profile is ‘Aggressive’ and you are looking to invest for more than 7-8 years. Move to the next step only when you have a clear answer to both questions.
Step 2: Determine the asset allocation
Put simply, asset allocation is a process by which we decide how much of our money goes to each asset class i.e. equities, and debt. Continuing from the above example, since we are an ‘Aggressive’ investor and have a time horizon of 7-8 years – we will allocate approximately 80% of our money to ‘Equity schemes’ given their potential to generate wealth over the long term. The remaining 20% will be invested in ‘Debt schemes’ due to their ability to protect us from the ups and downs of the market.
In investing, this is called an ‘80-20’ portfolio. And since there is no specific formula to determine an asset allocation, we that’s why use the ‘risk’ level and time horizon as inputs.
Step 3: Establish Core/Satellite holdings
After deciding on the asset allocation, we then split our portfolio into a Core/Satellite approach. In simpler terms, the ‘Core’ of your portfolio remains stable and does not require frequent changes. The ‘Satellite’ portion of your portfolio is one where you take more short-term, tactical bets.
E.g. If you are bullish on the Electric Vehicle trend, you can accordingly select a fund that has exposure to EV stocks. ‘Satellite’ holdings typically constitute about 20% of the allocation of the asset allocation i.e. If you are investing 80% in equities, then about 20% x 80% or 16% can be invested in such holdings. The balance is allotted to the ‘Core’ portion.
Step 4: Select the appropriate funds under the selected scheme category
Once the asset allocation has been decided and the ‘Core/Satellite’ split is done, we then move on to selecting the appropriate schemes from each of the categories. Now, fund selection is a bit more complicated in that it requires assessing the quantitative and qualitative of each of the funds. Again, for the simplicity of this post – we have selected 4-5 equity mutual funds for our equity allocation and 2 debt mutual funds for the balance. For the equity allocation, before selecting funds make sure that you check the holdings overlap between to make sure you are adequately diversified.
|Asset Class||Core / Satellite|| |
Step 5: Rebalance and monitor periodically
Finally! Your portfolio has been created. If it has been done rightly, you do not need to monitor it daily. Investing in mutual funds and stocks requires two completely different mindsets. Review your portfolio once every quarter/bi-annually and re-balance it to its original asset allocation if it has drifted too far away from it. Adding unnecessary complexity with frequent buying/selling will only add to your tax bill.
1. What are the 5 types of mutual funds?
The five official types of mutual funds are – a) Equity schemes b) Debt schemes c) Hybrid schemes d) Solution-oriented schemes and e) Other schemes
2. How many mutual funds are good in a portfolio?
If done correctly, you do not need more than 4-5 funds in your mutual fund portfolio for your equity allocation. For your debt allocation, have at most 2 funds across different sub-schemes.
3. How often should I review and rebalance my mutual fund portfolio?
You should review your portfolio once every 3-6 months to track its performance. However, if a particular fund is not performing to your expectations – give it some time. Every fund goes through its cycle. Do not frequently update your portfolios.
4. If I follow the above process, can I be assured of good returns?
The outlined process is simply a more disciplined approach to investing in mutual funds. The returns are not assured.