How do you know your Mutual Fund portfolio is good?
With ample number of schemes for investment in mutual funds providing lucrative annualised returns, investors get spoilt for choice. It mind sound to be an easy task to plough surplus funds in such schemes on a regular basis or for elongated time horizon but making the investment decision for selecting the right portfolio of funds is one tough nut to crack. Looking at historical performance while zeroing on the portfolio selection without pondering much over the performance consistency, downside risk and inherent risk brings along its own set of associated dangers. Very often unscrupulous financial advisors manipulate the investors to pool their funds in risky sectors which might not be very beneficial in the long run.
To sum up you might compare wealth creating through building a solid portfolio with the slow and steady test cricket where a whirlwind hundred will not be of much help in winning the series. Here funds will need the solidity of Mahendra Singh Dhoni rather than the flamboyance of Virat Kohli to emerge as the ultimate winner at the end. But finding the right mix can be highly confounding as a wrong decision can make investors loose big sums gradually.
So how do you as a layman select the perfect portfolio for parking your cash? You look at three basic things; time horizon of investment, investment objective and risk appetite you are comfortable with. Investment plan can help the investor choose the fund category among debt, equity and hybrid. Schemes can be selected within a particular category based on peer comparison, past performance, volatility measures, benchmark, expense ratio, scheme size and risk adjusted performance of the same. Today I will share a few pointers which I personally look at for maintaining a healthy portfolio.
Tips & Tricks
- Fund house to which the fund belongs has a big role to play in determining its financial stability. A strong parentage ensures business building capability and efficient operational process. Built on a strong base of operational efficiency and risk measures, such fund houses pave way for sustained performance in the long run.
- Consistency in fund performance is the top requisite for building a healthy portfolio. After all nobody would like to hold an equity fund generating 100% return in bullish market but with NAV taking a steep downturn in volatile market. I look for funds which have outperformed its benchmark indices over a time frame of 3, 5 and 10 years.
- Risk return trade-off is an important issue in portfolio building as a fund with high degree of risk involved is not worth the money if it does not provide adequate return. For this I often look at the Sharpe Ratio of the required fund which depicts the excess return generated by my fund over the return generated from a risk free instrument like term deposits of banks or government backed debt papers divided by Standard Deviation. This ratio shows the volatility of the fund.
- Since tender age our financial gurus had been instructing us not to lay all our eggs in the same basket. The portfolio building concept of mutual funds is based on the same school of thought. The more diversified the portfolio, lower is the associated risk in comparison to a portfolio having bias towards a particular asset class, stock or sector. The fund house showcases monthly performance of its various schemes in their website. I also double check the fund performances from the websites of various mutual fund trackers like ICRA Online and Value Research.
- Whenever I have to choose between two identical funds, I compare the expense ratio of the same. This ratio indicates the annual expense incurred by a particular fund expressed as a percentage of its average net asset. Lower expense ratio is beneficial in the long run. Schemes having bigger asset base have lower expense ratio. With increase in fund size, the associated fixed expenses get a wider spread over more investors thus bringing down the expense chart and leaving greater quantity of fund for investment.
Diversification is good but over diversification can shift investors from their ultimate financial goals. Holding excess funds makes its tracking a cumbersome and time consuming process. Such also happened with me when I started out in the investment arena. My haphazard investment decisions did not help me much in identifying the poorly performing funds which I always ignored which gauging the overall performance of my unmanageable portfolio. And the situation has given more clarity on how to invest in mutual funds? As a result of which I took the decision of narrowing down my portfolio to maximum of 8 mutual fund schemes diversified across various asset classes and market capitalizations. My portfolio had three large cap equity schemes, three diversified schemes, one small and mid cap scheme and one gold ETF/ debt fund (you can choose amongst any of the two). If you want to strengthen the tax saving frontier then I shall advise you to replace large cap or diversified funds with ELSS mutual fund options.
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About the Author: Pratik Rakte is passionate about personal finance topics and regularly writes at Financial Hospital.