Personal Finance

3 mistakes to avoid when building your mutual fund portfolio

Parvatha Vardhini C BL Research Bureau | Updated on October 16, 2021

We list a set of Do’s and Dont’s that MF investors should consider

The market rally since the March 2020 lows has brought in many new investors into the mutual fund (MF) fold. But are you investing right?

Here are three traps you should not fall into on the path to wealth creation through MFs.

Lacking goal-oriented approach

Latest available AMFI data (June 2021) show that retail investors contribute 54.82 per cent of the total AUMs of actively managed equity schemes — much higher than contributions to categories such as hybrid, gilt, debt or even index funds. However, only 55.6 per cent of the retail AUMs in equity funds were held for more than 24 months. This implies that while putting money in equity funds is a preferred route for retail investors, at least half of them are adopting a tactical, short-term approach rather than a strategic, long-term, goal-oriented approach to equity MF investing.

This assumption is also vindicated by a BL Portfolio survey on impact of Covid on personal finances done earlier this year as well as by the reader queries we get on their MF holdings.

A striking fact noticed among many survey respondents as well as among readers, who send in their portfolios for review, is their lack of delineation between long-term goal-based savings and other savings. Many invest in MF SIPs without any particular time frame or goal in mind. When they have any requirement — be it an emergency, a lifestyle need such as a new phone or laptop or a foreign holiday, they sell out or at least book partial profits. And the process goes on. Whatever remains from the additions and drawings over the years is their savings in equity MFs towards longer-term goals such as children’s education or retirement.

The ideal way to go about MF investing is to create a core portfolio for long-term goals and not touch this investment for other reasons. The core portfolio should consist of a combination of categories such as index funds, flexi-cap/multi-cap funds, mid and small cap funds in a proportion that suits one’s risk appetite.

For other needs on the way, tactical investing can be adopted. Informed investors can use sector or thematic funds — where timing the entry and exit assumes importance — as part of their satellite portfolio, for instance. Similarly, investors who follow the markets closely can do lump-sum investments during market lows and tactically move the gains out when a short-term goal comes closer.

While creating a separate fund portfolio for short- or medium-term goals, one must remember though that a horizon of less than 5-7 years pegs up the risk of investing in equity funds. Hence, monitoring the performance closely and booking profits is a must. Otherwise, one can also consider appropriate debt funds depending on the time to goal.

Stagnating SIPs

Another oft seen behavioural tendency among MF investors is the failure to increase their savings in tandem with their income. ₹10,000 a month in SIPs by a 30-year-old till he/she retires at 60 will grow to ₹3.52 crore assuming a reasonable 12-per cent CAGR. Stepping up the SIP by just five per cent annually can leave one richer by more than a crore. Stepping up by 10 per cent annually will take it to over ₹8 crore. Saving more as you earn more can make up for lower than expected portfolio returns. Returns can be lower for reasons such as sub-optimal fund choices and failure to review portfolio in time, lower alpha generation by certain categories of actively managed funds or by plain market volatility or bearishness in the years closer to your goal. Stepping up also helps in case you decide to retire early – a decision which cannot be foreseen when you have just started working or just begun saving.

Thirdly, to some extent, stepping up SIPs can also take care of your failure to account for inflation or misjudging it – the cost of your child’s professional education say, 20 years down the line, will not be the same as it is today. If it requires ₹10 lakh in today’s scenario, it will be at ₹26.5 lakh then, assuming a five per cent inflation.

Fund houses offer step-up/top-up or SIP booster facilities which will help increase your amounts annually. If you are confident of your fund choices, you can use this facility on one or more of your existing SIPs. Else, this annual exercise can be done manually, too.

‘When’ to exit

Consider this. A 10-year SIP in a leading large-cap fund ending on February 1, 2020, for instance, would have yielded 12.75 per cent CAGR, assuming you sold the investments to meet your goal when the tenure ended. The same SIP ending on April 1, 2020 would have decimated your returns to about 5-5.5 per cent, thanks to the March 2020 market crash. Equity investments are indeed subject to such market risks and hence, staying invested until the day of retirement or until the week your child’s higher education fee has to be paid, is not a good idea. A cardinal rule in goal-oriented equity MF investing is moving out the corpus a bit in advance when the going is good and when you have also got returns commensurate with the risk ( 12 per cent plus CAGR on your portfolio can be a goalpost). The corpus can then be reinvested in short-term fixed deposits to preserve the capital.

That said, ‘when’ to move out is not an easy decision. You need to avoid falling short of the corpus because of cautiously moving out to preserve the gains. You should also keep the taxation rules in mind — your corpus is what you get after paying long-term capital gains tax on gains over ₹1 lakh on equity funds; SIPs made in the last year before selling out are subject to short-term capital gains tax too. In this whole process, you can avoid pain by arriving at your corpus requirement scientifically, beginning to invest early, choosing the right funds, monitoring their performance regularly and by increasing your savings as and when your income goes up.

Published on October 16, 2021

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