How To Tailor Your Mutual Fund Portfolio To Your Goals

With steadily dwindling FD rates and increasing awareness about the poor returns afforded by traditional insurance policies, more and more savers are turning to Mutual Funds as a goal achievement tool. This is underscored by the fact that the industry’s assets topped an impressive Rs. 37 Lakh Crores last month! 

Despite their burgeoning popularity, there’s a broad lack of awareness about how to best utilize Mutual Funds as a systematic savings tool for one’s goal achievement. Should you invest in funds purely based on your risk appetite? Should you invest in equity funds, debt funds or balanced funds? Should you treat short-term goals and long-term goals the exact same way? Questions abound.  

If you’re confused about how to align your future goals with your Mutual Fund SIP’s, here’s a ready reckoner. 

Take a basic risk profiling quiz… but don’t get fixated on the results 

Start with a basic risk profiling quiz that’ll help you assess your attitude to risk-taking. However, understand that risk profiling works slightly differently when applied to “wealth creation” and “wealth management”. With wealth management (that is when you’ve already got money to invest), risk profiling plays a very key role in determining your optimal asset allocation between high risk and low risk investment instruments. The dynamics of wealth creation are different, as you’ll essentially be investing small sums of money on a recurring basis, towards goals that may be several years or even decades away! When you’re investing a large sum of money with the simple objective of generating optimal returns from it, it’s essential that the portfolio is structured in a manner that the swings are tolerable to you, and the returns are acceptable to you – not doing so could lead to all sorts of irrational investment decisions. For goal planning, however, the purpose of risk profiling is more to ‘fine tune’ your choice of savings instrument and also become vigilant towards your innate behavioral traps if need be. For instance, you may be a conservative investor with a 30-year goal of creating wealth for your retirement. In such a scenario, should you stick to low-risk, debt-oriented funds or recurring deposits simply because they’re in sync with your risk tolerance levels? The answer is an emphatic ‘No’. 

Time horizon must take precedence 

The overwhelming determinant of your choice of Mutual Fund needs to be your goal tenor, or time remaining to your goal. For instance, if your goal is to accumulate a corpus for your 5-year-old child’s higher education, you’ve got a good 13 years to go. That’s a fantastic time frame for a recurring equity investment, and there’s a good chance that you’ll be able to achieve a CAGR of 12% or more. For any goal that’s more than 7 years away, consider SIP’s in pure equity funds instead of hybrid or debt funds, regardless of your risk appetite. If you’re a conservative investor, you may want to tweak your choice of equity fund; for instance, choose to save in less volatile blue-chip equity funds instead of the more tempestuous small and midcap ones. 

Conversely, any short-term goal (less than 3 years away) should have as little an equity exposure as possible. The time horizon isn’t long enough to lead to any serious rupee-value differential as the real effect of compounding only starts kicking in after a decade or so. For example: If you save Rs. 10,000 per month in an equity-oriented fund growing at 12% CAGR for 3 years, you’ll end up accumulating roughly Rs. 4.3 lakhs. With a debt fund providing you with an estimated 8% return over the same period, your accumulated amount would be Rs. 4.05 lakhs. In this case, the potential incremental Rs. 25K gain isn’t justified by the short-term risks associated with equity investing; if you’ve lucked out, you might just end up with a negative return from equity SIP’s over a 3-year period! 

For any goal that’s between 3 and 5 years away, hybrid funds or dynamic asset allocation funds make for good choices. 

Spare a thought for Liquidity too 

Some goals require a very clear, lump sum amount of money at the end of the goal tenor, whereas some goals will require interim liquidity – some planned, some unplanned. For instance, your goal may be to set up an emergency fund, which is characterized by unpredictable and sometimes large drawings. Therefore, this money must ideally be put away in low-risk, low-volatility funds such as ultra-short term debt funds. On the other hand, paying for your child’s undergrad tuition fees may require four distinct, predictable lump sums of money. Since the 4th year tranche effectively affords you a much longer saving time horizon, you can actually save for it into a more aggressive, higher return potential fund.  

The dynamics of goal planning are different from the dynamics of ‘investing’. Don’t let your risk tolerance get in the way of your selecting higher growth instruments. Rather, use risk profiling as a process for building self-awareness and fine tuning your investment choice (for example, blue chip fund over small cap fund) instead of dictating the choice of asset class altogether (for example, debt instead of equity).