Making MFs Work Better
11/8/2010 2:47 PM Monday
Mutual funds have proven their worth as an ideal investment vehicle to millions of investors the world over. In India too, investors are gradually waking up to the inherent advantages of this investment option. Going forward, MFs are likely to play an important role in investors’ portfolios, especially for those who look to make their money grow at a healthy rate in a tax-efficient manner. However, to achieve success, investors will have to follow the correct strategies and enhance their awareness about various factors that can influence the final outcome. Here are a few of these:
Asset allocation is a method that determines how one divides one’s portfolio among different investments. Following an asset allocation strategy helps one to have the proper blend of different asset classes in the portfolio and that too in the right proportion. In other words, asset allocation helps in controlling risk in the portfolio as different asset classes react differently to changes in market conditions such as inflation, rising or falling interest rates or a market segment coming into or falling out of favour. The key is to understand that asset allocation is different from simple diversification. While having a few funds in the same asset class would provide diversification to an investor, it will not control the risk in the manner that an appropriate allocation to different asset classes such as debt, equity, gold, and commodities would provide to his portfolio. Mutual funds are the most appropriate vehicle to practice asset allocation successfully. They not only provide diversification but also offer a ‘family of funds’ to suit investment objectives of the investors in different age groups with varied time horizons and occupations. Moreover, they also provide opportunities to re-balance the portfolio, which may be required as a result of changes in the circumstances.
Total return is the sum of two components - dividend and capital appreciation. For an MF investor, these elements provide the ‘big picture’ of what his investment is doing for him. Therefore, while selecting funds, keep an eye on the total return rather than considering either dividend or change in the NAV alone. By doing so, one can be reasonably sure of having a consistent performer in the portfolio that can go a long way in achieving one’s investment objectives.
A portfolio turnover reflects how frequently securities are bought and sold by the fund. A 100 per cent portfolio turnover rate indicates that the portfolio was completely turned over in a year. Portfolio turnover generally varies with market conditions and investment category. For a MF investor, it is important to know that an aggressive equity fund is most likely to have high turnover rates. Some debt funds that seek to take advantage of the movements in the yield curve also have high turnover rates. Remember, a fund with a high turnover rate will incur more transaction cost compared to the one with lower turnover. Therefore, unless one is reasonably sure about the fact that higher turnover is likely to provide superior returns, such funds should be avoided. Investors can find out about the fund’s policy on portfolio turnover in the ‘offer’ document.
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