Mutual funds are fast becoming a popular investment choice for many. However, it is challenging for most investors to build a diversified portfolio that is in line with their financial goals and risk profile. Mentioned in this post are a few pointers to help you create the right portfolio.
Building a mutual fund portfolio is essential to reaching your financial goals through proper planning and investing. A well-built portfolio can help you achieve your goal while safeguarding you against various risks along the way. However, building a portfolio from scratch can often be overwhelming for many investors.
It is important to give a good thought on the parameters, risk factors, returns, time, and your goal before you build a mutual fund portfolio. While there are many things to pay attention to, here are three factors that can help you get started.
Let’s understand the importance of deciding on your goals through an analogy of travelling or planning a vacation. Just as there are many tourist destinations in the country, there are many components in mutual funds If you know what your goal is or what your preferences in terms of finances are, you will be able to choose better.
There are three main types of financial goals:
These are goals that would like to realise over the next 1-5 years, such as vacation, marriage, etc.
Goals that you want to accomplish in the next 5-10 years, such as buying a new car, home renovation, etc.
Goals that you wish to achieve in next 10-30 years or more such as retirement plans, children’s higher education, buying a home, etc.
When you’re building a MF portfolio, it is essential to know whether you have short-term or long-term or mid-term goals. As this will help you decide the kind of mutual funds you need to include in your portfolio.
If you have more short-term and ultra-short-term goals, you may like to consider including more of comparatively low-risk options that come with lower-return potential such as debt funds.
For these goals, you may consider filling up your portfolio with more of equity-oriented funds that come with high-return potential but are also known to carry comparatively higher risks which can be balanced out in the 5-10-year time frame.
For these goals, you can employ various strategies to build a diversified portfolio. For instance, you can start with funds with higher equity exposure and more to comparatively safer debt funds or fixed income funds as you reach closer to your goal.
As an investor in mutual funds, you should know where you stand in terms of the risk factor. Or, better put, how much risk you are willing to take. You will come across different terms such as risk profile, risk appetite, risk tolerance, etc. Your risk profile is your willingness to bear risks. The risk appetite is the same. Risk tolerance is how much risk you can take up in real-time.
There are usually three types of risk-tolerance levels:
Based on the risk-bearing capacity, there are three popular types of mutual fund portfolios:
This is usually recommended for young investors that have a long-term horizon with more than 10 years for investments and have a high-risk tolerance. Such a portfolio can have a high component of equity exposure with low debt exposure.
This kind of portfolio has slightly less exposure to equity than the aggressive portfolio with the rest of the component dedicated to debt. It is usually recommended for medium-risk appetite investors who have more mid-term goals and are in usually in the middle of their careers.
This is best suited to low-risk investors or those who have more short-term goals (1-5 years) that they would like to achieve. They would have a much higher debt-exposure with low equity exposure.
If you get stuck and wonder how to build a mutual fund portfolio, look at the core and satellite method. An effective and popular method for building a mutual fund portfolio, it helps you build a diverse portfolio.
The placement of funds in your portfolio is akin to two concentric circles. The inner one is the core, and the outside circle is the satellite. The core section aims to provide stability to your portfolio while generating steady-returns. The satellite portion, on the other hand, covers high-risk funds and higher returns.
This table will help you understand the concept better:
|Constitutes a major part of the portfolio||Need to be around only 10-30%|
|Gives steady returns but is stable||Diverse as well as high return potential|
|Risk is low||High risk|
|Examples are index funds, large-cap funds, etc.||Examples include sector funds, small-cap stocks, thematic funds, etc.|
If you are new to mutual funds, take your time to learn about the basics first. Even if you have an advisor, you should understand all the terms correctly. It will help you make an informed choice that suits your financial goals and risk factors. Invest in sound schemes that work best for you, but make sure you weigh-in all the risks associated carefully before investing. Lastly, always remember that it is not one mutual fund scheme that can help you achieve your financial goal but a portfolio that helps you reach there. However, start building your portfolio one fund at a time.