In the 3 portfolio strategy that I advocate, Mutual Funds have a special place. They are an investment vehicle that lets you participate in equity as an asset class, without the necessity of any great understanding of the markets or business. For a person who is stepping into equity investments for the first time, MF offers good learning potential. Being with MF for some time can be an ideal platform to transition into direct stocks.
Unlike debt where your investment strategy and choice of instruments will depend on your stage in life, the MF investment strategy is roughly the same for all kinds of investors albeit with some nuances in approach. I have written about it extensively in the blog on various aspects of MF investing and will therefore not repeat it here. Let me instead outline the key aspects of MF portfolio building that you must follow.
- Number of funds: Several people may tell you that you can do all your MF investments with 1-2 funds. Nothing can be further from the truth. Different categories of funds have very differing mandates and in order to get adequate market coverage you need multiple funds in your portfolio.
- Portfolio composition: My suggested composition will be as follows:-
- 1 large cap oriented fund
- 1 multi-cap or diversified equity fund
- 1 mid cap fund
- 1 small cap fund
- 1 international fund with US bias ( optional )
- Buying mechanism: While SIP is the most common mode of buying there are serious conceptual flaws in this mode. I prefer buying MF based on the relevant indices movement. Read my posts in the blog if you want to invest intelligently. If you do not have the inclination or time then just do SIP, even with the flaws it will work.
- Relative weights: I personally prefer allocating equal weights to all funds in my portfolio. However, this is an area where your investment attitude should take over. Do what you are most comfortable with and, if needed, change over a period of time. It is ok to allocate 50 % of your money to large caps if you are not a person who can deal with volatility very well. On the other hand if you are comfortable with taking risks allocate more to mid and small caps.
- Portfolio rejig: Ideally review your portfolio once a year and compare it with your targets and the benchmark indices. If the fund seems to be doing ok, do not change it. Normally I prefer a change only after 2 years even though you may need to act sooner if performance is poor.
- Choice of funds: I have deliberately kept it till the last as it is one area where investors are most confused about. You do not need calculators or any deep kind of analysis with all kinds of ratios in order to choose MF. There are fairly good ratings done by companies and people who are professionals in handling these. Just go with them, it is not rocket science. Most fund managers invest in the universe of 250 companies or so with most investments going into the top 100 One good fund is really similar to any other.
So that is really all you need to do in building up a good MF portfolio and investing in it. Read my other posts in the blog for details if you want.