Which mutual fund will offer you the best returns

It is common knowledge that unless one invests regularly it is difficult to achieve financial freedom. Thanks to mutual funds, one has a credible alternative to begin one’s investing journey.

Introduction

It is common knowledge that unless one invests regularly it is difficult to achieve financial freedom. Thanks to mutual funds that yield best returns, one has a credible alternative to begin one’s investing journey. But figuring out which mutual fund is suitable for an investor has never been easy. Before reclassification, at last count, there were more than 2000 mutual fund schemes in India. After the reclassification mandate passed by SEBI, mutual funds will be divided into 36 categories. This requires each Asset Management Company (AMC) to divide its mutual fund offerings along these 36 categories. But for an investor, to get best returns on mutual funds, it still may be difficult to make the correct choice. In this article, we seek to assist the investor to decide which mutual fund is most suitable according to age, risk, goals, diversification and skew.

According to Age

There is a Thumb Rule, which says that one should invest the percentage of 100 minus our current age i.e. (100 - Age) % in aggressive funds (small cap and mid cap) and the remaining in balanced/large cap funds to get best returns.

Lumpsum investing also makes us bite the bullet by offering some hard realities. We have listed them below:

Proper asset allocation is imperative. There are three asset classes available i.e. equity, debt and cash. We should decide a ratio in which we assign our capital to these asset classes.

When we are in our 30s or in a preceding age range, we should pick up the most aggressive funds and watch them grow over 30 years. There is no one single size that fits everyone, but by the time we are in our 30s, we start saving money. At that time, we have 30 years for the goal like retirement. Hence we can hold on to the investment for a long period of time.

When we reach say 45 years, we can switch to equity-oriented balanced funds.

When we retire, we should opt for safety of capital, which gives us our monthly return.

However, the above can vary from person to person. But in today’s world with inflation eating into our hard-earned money, we have to be more judicious about our investments.

According to Risk

An expert once said that one should only take as much risk so as still manage a sound sleep at night. Risk appetite however, has a nexus with investment goals. Senior citizens investing for regular monthly income will naturally have a low risk appetite compared to a person who is investing with a 10 year horizon for kids’ education.

Balanced mutual funds and Large caps mutual funds are suitable for someone who is risk-averse.

Balanced mutual funds invest a mix of equity (at least 65%) and debt. These schemes are less volatile than pure equity funds because of the mixed portfolio. The debt investments provide stability in times of volatility. These mutual funds are suitable for new stock investors and conservative equity investors.

Large-cap funds invest mostly in big companies. Funds identify these companies by their market capitalisation. These companies are considered safe to invest because they are likely to be well-established players and leaders in their respective filed and can proliferate best returns. This is the reason why large-cap funds are considered suitable for conservative equity investors. These funds are likely to offer modest returns as they carry relatively less risk.

If you can deal with risk, invest higher percentage in small and mid cap or sector funds.

Midcap funds invest mostly in medium-sized companies. These companies can be risky as they may or may not realise their full potential. However, if they succeed, they will become large companies and investors will be rewarded handsomely. Investors with high risk appetite should bet on these funds.

Smallcap funds invest in small companies. These companies can be extremely risky and thus exhibit volatile performance over a shorter period of time, as there will be very little information about them available in the public domain. However, they can also offer phenomenal returns. They are suitable only for investors with a very high risk appetite.

Sector funds invest mostly in a particular sector or along the lines of a defined theme. Since the investments are concentrated on a single sector or theme, sector funds are considered extremely risky. It is very important to time the entry into and exit from them as the fortunes of sectors changing in different cycles in the economy. They are meant for investors with an intimate knowledge about a particular sector. Investors should take only a small exposure in them.

According to Goals

For short term goals

Planning for short term goals is different from long term goals. Objective of Short term goals is safety over growth and liquidity. Mutual funds have various categories of schemes that cater to short term investments which can help you in meeting your short term goals like planning for holidays or wedding or buying electronic gadgets or house renovation to name a few.

For very short term goals and for emergency fund you have to invest in liquid funds or ultra short term funds as emergency fund is a corpus where you would need funds immediately as and when emergency arises and hence liquidity and minimal exit load are critical drivers. These are funds that invest primarily into money market or short tenor liquid instruments but provide the flexibility to redeem the funds at short notice with minimal or no exit load.

If the goal is 3 years away, we can invest in an income fund or dynamic bond fund. These funds typically invest in corporate paper and are able to generate higher returns than bank fixed deposits in most cases.

For medium term goals

Some top of mind Medium term goals are saving for a down payment to buy a house or spending on one’s wedding or purchasing a car.

In order to achieve medium term goals, we can invest in balanced fund. When one opts for a balanced funds, where money is invested in debt and equity both. The debt portion works as a cushion and covers the impact if the equity portion is unable to reap great rewards. However, a combination of debt and equity largely increases the investor’s chances of reaping attractive returns with just a fair percentage of risk.

For long term goals

There are two common and most important of long term goals: Retirement planning and Children’s Education. What kind of funds are suitable for these goals?

To start with, both retirement and children’s education, need to planned much in advance. Since the time frame for these goals is minimum 8-10 years, you can invest in equity funds. One can start by investing aggressive small cap and large cap equity funds. These funds have higher exposure to equity and hence could have volatile returns. While investing for long term we are looking for capital appreciation and hence can take risk volatility of returns on our capital. However over a longer period of time, these funds also provide higher returns.

  1. Large Cap Funds invest in large-cap companies. The stock prices of these companies are considerably stable compared to overall market.
  2. Small-Cap Fund is extremely vulnerable to market ups and downs and carry higher risk. However, the reward for choosing higher risk is the attractive returns.

As we near our goals, we should start allocating some funds out of these small cap and large cap equity funds into balanced funds to reduce volatility towards the end. A strategy that gradually grows more conservative over time requires that us regularly rebalance the portfolio and ease up on your stock weighting as you get closer to our goal.

For Diversification

Gold funds

Gold shines, but investing in gold may not offer impressive returns. Should one invest in Gold funds then? Yes, for diversifying assets. We diversify into various types of mutual funds so that our assets remain secure. Similarly, we can contribute some part of our portfolio in Gold, which will remain safe and grow gradually and marginally.

Foreign funds

Investing in international funds, also supports the same logic of diversification. Returns depends on that country’s markets and forex movement. If we have extra money, it can surely go into funds. This also increases our awareness of global markets.

For Regular income

How do we sustain our standard of living after we actually retire? Regular income is of prime significance.

Mutual funds can provide regular income through 2 modes:

  1. 1.Monthly Income plans
    MIPs offer regular income by investing in mutual funds with a monthly divided option. Most of these funds allocate only 10-20% of their corpus into equities and the rest 80-90% in safer bonds and other debt instruments. MIPs are safe as they give investors good returns if stock markets do well, but they also protect the downside because of the limited exposure to equities. Though these are called monthly income plans, there is no guarantee of monthly income. Due to the presence of equity, returns can be volatile.
  2. 2.Systematic Withdrawal plans
    SWP simplifies retirement life by letting investors to withdraw from their mutual fund scheme every month on an already set date. This withdrawal can be just the capital gains or a fixed or a variable amount. The same can be made annually, semi-annually, quarterly or monthly.

Skewed Portfolio

This goes back to our golden theory of Asset Allocation. It may sometimes happen that our portfolio may get skewed towards a certain type of fund or fund house. It is then time to re-evaluate our portfolio.

Doing this is extremely important as we run the risk of not being able to liquidate enough cash when we are nearing a goal. Or we lose out on an advantage of investing in an aggressive portfolio while age supports us. Re-balancing portfolios is one of keys to keep our financial health secure.

Conclusion

Every individual’s needs, amount of income, aspiration and mindset are different. One should choose a mutual fund depending on these factors and not on the basis of what one’s friends or family members are doing.