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Many just think of surplus available with them for investment. But sadly forget to identify the financial goals, time horizon, asset allocation and finally the right funds.
Hence, before jumping into “How should I start investing in Mutual Funds?”, I want to make sure that you must know few basics of investment (including Mutual Funds).
I am not saying that Mutual Funds are BEST or WORST. At the same time other products also. Each product or asset will come with it’s own positives and negatives and also risks. Hence, it is YOU who must understand your RISK.
Below are few inputs from my end.
You must have a proper Financial Goal
I noticed that many of investors simply invest in mutual funds just they have some surplus money. The second reason may be someone guided that mutual funds are best in long run compared to Bank FDs, PPF, RDs, or even LIC endowment product.
If you have clarity like why you are investing, when you need money and how much you need money at that time, then you will get the better clarity in selecting the product. Hence, first identify your financial goals.
You must know the current cost of that particular goal. Along with that, you must also know the inflation rate associated with that particular goal. Remember that each financial goal to have it’s own inflation rate. For example, education or marriage cost of your kid’s is different inflation that the inflation rate of household expenses.
By identifying the current cost, time horizon and inflation rate of that particular goal, you can easily find out the future cost of that goal. This future cost of the goal is your target amount.
Asset Allocation is MUST
Next step is to identify the asset allocation. Whether it is short term goal or long term goal, the proper asset allocation between debt and equity is a must. I personally prefer the below asset allocation. Remember that it may differ from individual to individual. However, the basic idea of asset allocation is to protect your money and smoothly sail to reach the financial goals.
If the goal is below 5 years-Don’t touch equity product. Use the debt products of your choice like FDs, RDs or Debt Funds.
If the goal is 5 years to 10 years-Allocate debt:equity in the ratio of 40:60.
If the goal is more than 10 years-Allocate debt:equity in the ratio of 30:70.
While choosing debt product, make sure that the maturity period of the product must match your financial goals. For example, PPF is best debt product. However, it must match your financial goals. If the PPF maturity period is 13 years and your goal is 10 years, then you will fall short of meeting your financial goals.
Return Expectation
Next and the biggest step is the return expectation from each asset class. For equity, you can expect around 10% to 12% return. For debt, you can expect around 7% return expectation.
When your expectations are defined, then there is less probability of deviating or taking knee-jerk reactions to the volatility.
Portfolio Return Expectation
Once you understand how much is your return expectation from each asset class, then the next step is to identify the return expectation from the portfolio.
Let us say you defined the asset allocation of debt:equity as 30:70. Return expectation from debt is 7% and equity is 10%, then the overall portfolio return expectation is as below.
(70% x 10%) + (30% x 7%)=9.1%.
How much to invest?
Once the goals are defined with target amount, asset allocations is done, return expectation from each asset class is defined, then the final step is to identify the amount to invest each month.
There are two ways to do. One is constant monthly SIP throughout the goal period. Second is increasing some fixed % each year up to the goal period. Decide which suits best to you.
Hope the above information will give you clarity before jumping into equity mutual fund products.
How many mutual funds are enough?
How many mutual funds do we have? Is it 1, 3, 5 or more than 5? The answer is simple…you don’t need more than 3-4 funds for investing in mutual funds. Whether your investment is Rs.1,000 a month or Rs.1 lakh a month. With the maximum of 3-4 funds, you can easily create a diversified equity portfolio.
Having more fund does not give you enough diversification. Instead, in many cases, it may create you portfolio overlapping and leads to underperformance.
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