Why mutual funds should be integral part of your portfolio

Considering that financial products vary greatly in the degree, as well as type of risk and potential return, the endeavour should be to develop a sound portfolio that strikes the right balance between risk and reward. Simply put, your asset allocation should reflect your risk tolerance. Mutual funds have all ingredients required for an effective investment vehicle.

Why mutual funds
MFs are a simple, yet effective way to for achieving your investment goals without compromising on your risk tolerance. They are effective (managed by professionals), economical (low fee and expenses) and varied (many different kinds of schemes to choose from). Moreover, they provide an opportunity to earn higher post-tax returns as compared to fixed deposits, bonds and small savings schemes, albeit with varying degree of volatility. Select a few funds and leave the rest to the MF professionals. However, follow certain basic principles while investing in them. Before choosing a fund, have a fix on your asset allocation on the basis of your risk profile, time horizon and investment objectives. The selection of fund should be the last step in your investment process. Make sure your investment objective matches that of the fund. Once the suitability is ascertained, the key parameters in fund selection should be its investment philosophy, portfolio quality, past performance, corpus and fund size.

Avoid over-diversification
Although MFs are diversified, it helps to diversify investments across a variety of funds within an asset class. However, diversification would become counter-productive if you invest in too many funds. For example, if you invest in 15 equity funds, it does not necessarily mean that your portfolio is adequately diversified if most of them invest in the same market segments. On the other hand, if funds are chosen carefully, even a portfolio with just five funds could be more diversified. Build a compact portfolio without compromising on diversification.

Watch this Zee Business video here:

Monitor your portfolio
Monitoring the progress of your MF portfolio is as important as making the right selection. In this process, how you tackle the volatility holds the key to the level of your investment success over time. While continuing with regular investments is a proven strategy to minimise the impact of market volatility on your portfolio, any panic reaction to realign the portfolio is most likely to backfire. It is equally risky to invest short-term surplus money in a falling market to recover notional losses, as a prolonged correction phase may keep the stock market subdued. Often, short-term performance compels investors to make abrupt decisions. To avoid this, compare the performance of the funds vis-à-vis the benchmark and the peer group.

Hemant Rustagi
(The writer is CEO, Wiseinvest Advisors)
Source: DNA Money