Have You Chosen Your Funds Well?

Mutual fund industry's phenomenal growth has allowed Indian investors the freedom of choosing the most appropriate funds to achieve their investment goals. Mutual funds also score over other investment options in terms of flexibility, ease of investing, transparency- both in terms of where the money is invested and the costs involved, professional fund management and regulations governing their functioning. 

However, the variety of funds on offer has also been causing dilemmas to investors as there are thousands of schemes to choose from. It is quite common to see investors having portfolios that do not reflect their risk profile and investment objectives. Besides, large number of funds makes the portfolio unwieldy. No wonder, despite investing their monies through one of the most effective investment vehicles, they face disappointments from time to time.

Hence, to benefit from the real potential of this wonderful investment vehicle, investors must focus on making the right selection of funds. The key issue, therefore, is how should one go about it. If you have been facing this dilemma, here's what you need to do:

DECIDE YOUR ASSET ALLOCATION

It is quite common to see investors investing haphazardly in top performing funds. No doubt, past performance is one of the criteria for selecting the funds in the portfolio. However, relying too much on it and that too on a short term trend can either make your portfolio very aggressive or very conservative. Therefore, focus on asset allocation to begin with. Asset allocation allows you to decide how much of your money should be invested in different asset classes like debt, equity and gold.

Remember, asset allocation also decides the level of risk in your portfolio and what to expect in terms of returns. Your time horizon for each of your goals can go a long way in deciding the right asset class. For example, while investing for long-term goals like retirement planning and building a corpus for children's education and marriage, equity has to be the mainstay as you need to generate positive real rate of return, i.e., gross return minus inflation and taxes. Similarly, while investing for the short term, safety of capital has to be given top priority and, hence, debt funds should dominate this part of the portfolio.

A mix of equity and debt can be ideal for goals to be achieved over a time horizon of 3-5 years or so.

CHOOSE FUNDS FOR EACH ASSET CLASS

Once you have worked out your asset allocation, the next step should be to choose the right funds for each of the asset classes. Simply put, make sure your investment objective matches with that of the fund you choose to invest in.

For example, while deciding funds for long-term goals, you need to consider pure equity or equity-oriented hybrid funds. There can always be a temptation of investing in aggressive funds like mid-cap and small-cap, sector and thematic funds due to their impressive performance during certain periods. However, the key for long-term investment success is maintaining the right balance between risk and reward.

This step itself restricts your investment universe to a few hundred funds, instead of thousand of funds. Within that too, if you are a first time investor, you should be investing in large-cap oriented multi-cap funds that may be around 100 in number. Out of these, you can eliminate those funds that have not been performing well consistently vis-a-vis their benchmarks and the peer group.

AVOID INVESTING TOO MUCH MONEY IN A SINGLE FUND HOUSE

While the pedigree of a fund house can be an important aspect of the selection process, it should not be the sole reason for investing in a scheme. One often comes across portfolios wherein a significant part is invested in a single fund house. Needless to say, it is not a great idea, because by doing so, you may forfeit your chances of benefitting from the expertise of other fund managers and their investment philosophies. Besides, you must remember that mutual fund industry is a very well-regulated one and the regulators have done a great job of spelling out what a fund house can do and what it cannot. The core activity of a mutual fund is to manage your money as per the mandate given to it and, hence, the quality of the portfolio and the level of diversification should matter the most to you.