How can one balance mutual fund portfolio to fulfil medium term goals?

It is well accepted that any quest for returns entails risk, although it is not always true the other way round.

July 24, 2019 12:00 IST | India Infoline News Service
Risk Return
What exactly do we understand by medium term goals? While there are no hard and fast rules, there are some commonly accepted ranges that we can consider. In the Indian context, a period of 5-7 years can be considered to be medium term. What are the typical medium term goals that a person can have? You can have a 6-year goal to fully pay off your home loan. Similarly, you may have a 5-year goal to repay your education loan in entirely. Alternatively, you may have a 7-year goal to create a standby corpus of Rs20 lakhs to fund your home extension and reconstruction. All these are medium term goals. So, why do we look at medium term goals as distinct from long term goals?
It is all about the risk / return trade-off
  • It is well accepted that any quest for returns entails risk, although it is not always true the other way round. If you keep your money in a savings account you would earn 3% net of taxes and it would take 24 years to just double your corpus. Obviously that is not going to work. You can afford to take on more risk as the time horizon gets extended.
  • You obviously need to invest to meet your goals and therefore you need to match your investments to the tenure of goals. Here are some takeaways.
  • For a very short term goal with a tenure of 2-3 years, a liquid fund would serve your needs best. You can look at enhancing returns with a liquid-plus fund.
  • For a short term goal with tenure of 3-5 years, you can look at short term funds and some exposure to debt funds / income funds.
  • For a medium term goal with tenure of 5-7 years, you can look at options like debt funds, some exposure to balanced funds with an equity bias.
  • For a relatively long term exposure of 7-10 years, you can look at debt funds and some exposure to equity diversified funds and index funds.
  • Lastly, for a long term exposure that extends beyond 10 years, you can look at predominant allocation to equity diversified funds and even multi-cap funds.
How to go about fulfilling your medium term goals with mutual funds?
A medium term goal with tenure of 5-7 years can afford you some leeway in risk. While equity funds may still be risky, you can take indirect exposure to equity via aggressive balanced funds and park the rest in a debt fund. However, a medium term goal would actually require a multi-dimensional approach. Here is how.
  • There are three types of balancing that you need to do. Firstly, there is a balancing of risk versus returns. Then there is a need to balance liquidity and returns in the medium term. Finally, you also need to make the medium term portfolio tax efficient.
  • You need to take calibrated risk in the quest for higher returns. However, you cannot afford too much of price risk or price volatility for your medium term commitment. The idea is to help you compound savings at above-debt returns.
  • How do you balance liquidity? You obviously cannot put all your money in liquid funds if you have a 5-7 years perspective. That would be sub-optimal. A better way is to go for a combination of debt funds and balanced funds but look to monetize them into liquid funds at least 6-8 months before the milestone date.
  • Lastly, there is the tax balancing to handle. What matters are your post-tax returns? Aggressive allocation balanced funds are treated as equity funds with lower tax rates. With debt funds, opt for growth plans rather than dividend plans and work out a SWP, which is more tax efficient.
Before you start to plan your medium term goals, ensure that you have an emergency fund and insurance to cover you risk. You are absolutely good to go!

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