How to invest in mutual funds for financial goals

Kavya Balaji   /   September 3, 2020
financial goals

You might have heard financial experts tell you that you can invest in mutual funds for goals such as your retirement or your kid’s education. This is because over long periods, equities have the potential to outperform every other asset class. However, you can use mutual funds for short term goals like saving up for your dream vacation or that SUV you always wanted to buy. Here’s how to invest.

The basics

While drawing up a mutual fund portfolio, keep these basic rules in mind: know the broad categories of schemes in the market, their purpose and how they work. For instance, knowing the difference between income funds and gilt funds—where they invest, their portfolio and what kind of returns they are likely to generate- will help you choose the right fund.

Ensure that the mutual fund you choose matches your risk profile and investment objective. Let’s say you know that you need to invest in equity mutual funds for your retirement. However, you have a low risk appetite. In that case, you will be better off investing in index funds rather than actively managed mutual funds. So, respect your risk-taking capacity. Do not go overboard on equities if you are not comfortable taking on the risk. 

Earmark funds for each of the goals. Let’s say you are investing in ELSS mutual funds for your kid’s education that is 15 years away. ELSS funds have a lock-in period of 3 years. Once the lock-in is done, ensure you reinvest the money in another investment. Linking your investments to your goals will help ensure that you don’t use the money for other purposes before you achieve the goal.

As you move closer to your goals, start moving your money from equity mutual funds to debt oriented mutual funds. Say your kid is in class 10 and will go for engineering course after he completes schooling. Since you have only two years in hand, you should choose debt-oriented funds such as bond or short-term funds that will be available at any time. You also preserve your capital gains from equities if you move to debt mutual funds.  

The ideal way to build an adequate corpus for your goals is to go step by step. Earlier you start, the better money you will be saving. Of course, you also need to stop along the way occasionally to make sure things are happening as planned. The closer you get to your destination, the more careful you need to be.

Choosing the fund

Have a mix of large- medium- and small-cap equity schemes if you are investing for long term goals. If you will need the funds in about 8-9 years from now, opt for mid and small cap funds. However, if the goal is five years away, you may want to stick to large-cap funds as they invest in well-established, top-rung companies and are, therefore, less volatile. They give reasonable gains when equity markets rise and are also comparatively less volatile when equity markets fall.

High risk funds like thematic funds can be considered to get the kicker in returns only if you have a higher risk profile. The idea is to take the equity advantage and yet control the risks you take. Choose well-performing equity schemes with established track record.

If you are investing for the short term which is more than one year, choose from a range of income funds, credit risk, dynamic bond funds, duration funds and bond funds. If you can take higher risks, you can invest in thematic debt funds such as Sundaram Banking & PSU Debt Fund. If you need to invest for less than a year, you could invest in liquid funds and short-term debt funds.

Diversification across funds

Diversify across and within mutual funds. Don’t diversify for the sake of diversification or over-diversify within asset classes. You can invest in up to three schemes in a category at most. Remember, one of the reasons you have opted for mutual funds is because you do not want to spend a lot of time on your investments. But you might spend more time on your mutual funds if you scatter your money across too many schemes. The rule holds true whether you are investing in the equity or the debt market. If you invest in too many schemes with the same or similar style, you could end up investing in same stocks through multiple funds. Even though there is no fixed number as to how much one should hold in one’s portfolio, it can be at the most 7-10 schemes. This makes it easy to manage your portfolio.

Portfolio review

If you think that your job is done once you have put your money in mutual funds, think again. Your portfolio may contain star performers, but just a couple of oversights could affect their performance. So, track your scheme’s Net Asset Value (NAV) on a monthly/quarterly basis. Look for changes in the scheme’s portfolio. Compare the scheme’s performance with that of the benchmark, or similar schemes of other mutual funds. Ensure that the fund is adhering to the fund objectives stated in the offer document. Read all those various periodic statements such as newsletters, and half-yearly and annual reports. Make sure you track your fund at least every 18-24 months.

Choosing the right mutual funds for each of your goals will help you achieve them without hassles and in right time.

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