Month: May 2022

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How many mutual funds make a good Portfolio

If you are investing in mutual funds, you may have asked or been told about diversification and the number of mutual funds you should own to make your portfolio stronger, and safeguard your investments from sudden market risks.  

It is necessary to ensure that your investment portfolio is diverse and you don’t have all your eggs in one basket. At the same time, it is also true that too much diversification can prevent you from making high gains. This gives rise to the question of how many mutual funds you should have and how much is too much. 

Diversification vs. overdiversification 

Diversification of investments is done with the aim of spreading the risk out across a number of assets. If you have invested too much in the stocks of a single company, your investment is at greater risk, because if the company does not perform well, it’s share prices drop and so will your investments. To mitigate this risk, you should diversify your investments and invest in multiple companies, so as to ensure that even if one company does not perform well, the investments in the other companies helps you overcome that loss. 

However, investing in too many companies can result in you not being able to make the most of your investments. Even if one of your investments does really well, you will not be able to see a great difference in your corpus because your investments are spread thin and the investment in any one company is bound to be smaller. It is usually suggested that you keep your investments diversified across industries, but limited to a few companies per industry. 

How many mutual funds should you own? 

Since there are several types of mutual funds, let us talk about each kind of mutual fund specifically. 

Large-cap equity mutual funds make their investments specific to shares of large-cap companies. Investing in one large-cap mutual fund that is well researched and chosen diversifies your investments enough that a second one is not strictly necessary, but can be an option. Owning multiple large cap funds increases the chance that there is a significant overlap in the shares owned by these funds and does not really guarantee more diversity in your holdings. 

Mid-cap equity mutual funds, as the name suggests, diversify their investment across companies belonging to the medium capital spectrum. These companies have much higher growth potential compared to companies belonging to the large capital spectrum. However, the risk involved with mid-cap mutual funds is also considerably higher.  

There exist a lot more mid-cap companies than there are large-cap ones. This means that even if you invest in multiple mid-cap mutual funds, the chances that there is significant overlap in your investments is smaller. This means that you have more options to invest in, but only invest in mid-cap funds after you have throughly researched them and are confident in their prospects. 

Though the high potential return can increase appeal for these funds, remember that there is a higher risk factor associated with these funds, which may be detrimental for your overall portfolio if things do not go your way. For mid-cap funds too, you should limit yourself to two funds only. 

Small-cap mutual funds, as you can probably guess by now, invest in small-cap companies. Investing in them is a high risk, high reward strategy. If they do well, you stand to earn extremely high returns, but if they do not, you could lose out on a lot of your initial capital. Given the number of companies that fall in this bucket, the chances of your investments overlapping are smaller and the reason you should limit yourself to approximately two of these is more because of the risks associated with them. Again, only invest in small cap funds after a lot of thorough research. 

Debt Mutual Funds are investment schemes that allocate your funds to bonds and other similar market instruments. These are considered very safe and low risk investment which means that the returns are also low. You can probably invest in one or two of these as well, but investing in more than that means lower returns overall. 

Sectoral Mutual Funds allocate your funds to companies from one particular industry. This is very similar to investing in only one company, since if the industry as a whole sees a downturn, your investment in it will also take a hit. These funds are only a good option if you happen to be an expert in, or know a lot about, that particular industry. The number of sectoral mutual funds you invest in depends on the industries you are familiar with. If you’re not sure about a particular fund or industry, it is best pass on these them. 

Though there is no exact number that is right for everyone, anywhere from six to ten mutual finds is usually the number of funds you want to be invested in. But this, by no means, set in stone. You could invest in more or less depending on multiple factors, such as your risk tolerance, your expected returns, your knowledge of particular industries etc. You should always ensure that the funds you are investing in are of different types, rather than funds with different names but similar outputs. As always, please research thoroughly and consult your financial advisor before making any financial decisions. 

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Mutual Funds for Tax Saving

May 20, 2022

One of the largest avenues of income for most governments is the taxes that it’s citizens are required to pay, in various forms. This income is then used to fund the development of the country in various areas. We should never consider income tax as a burden, but as an essential responsibility that helps move the wheels of the country’s economy. 

The Indian government has many provisions that allow you to make investments of your choice to increase your wealth, and at the same time, help you cut a significant amount from your taxable income. Cutting down on taxes by making investments also has a number of benefits, which we shall discuss below. 

Why should you incorporate tax-saving investments to your portfolio? 

Incorporating tax-saving investments to your portfolio ensures that you have a head start on your financial future. A longer duration for your investments to grow not only means more returns for you when the investment matures, but also that you get them when you need them the most, which is towards the end of your career. The earnings from these investments that you make over a long period of time will help you cover for your expenses later in life. 

The habit of planning your investments to save tax is also financially healthy because you tend to set aside a portion of your income in order to make investments, which can help protect your finances and future in the long run. Tax-saving vehicles also offer multiple other benefits apart from just helping you save your taxes. They are mostly long-term plans that build a corpus over a long period of time and help you meet your long-term financial goals, like retirement. 

Tax Saving Mutual Funds 

As already implied by the name, these are just like other mutual funds, but with an added benefit of saving taxes. The speciality of these tax saving mutual funds is that they make investments which provide tax redemption benefits under Section 80C of the Income Tax Act. Most of these Mutual Funds are Equity Linked Savings Schemes (ELSS) which investment into the equity market, and are growth oriented. They usually come with a lock-in period of around 3 years, which also helps you inculcate a good habit of investing. 

How do they work? 

When you invest in a mutual fund, your money is pooled into a larger fund. This accumulated capital is then invested into the equity market in a manner such that even if one of the investments incurs a loss, the other investments help mitigate the same. 

The long term capital gains from these Equity Linked Savings Schemes are not taxed, and the investments made are eligible for a tax deduction of upto Rs.1.5 lakh. 

Tax saving mutual funds make investments with at least 80% of their assets into equities. These mutual funds also allow you to invest all the year round, since these are open-ended in nature.  

Schemes under the ELSS funds can be categorised into two section: dividend schemes and the growth schemes. The dividend schemes provide you an extra income as dividends from the fund house from time to time, depending on the availability of the surplus which is distributable. On the other hand, the growth schemes operate towards generating long-term returns that you can redeem upon maturity.  

The dividends you derive from dividend schemes are untaxed, and can be withdrawn even during the lock-in period or can also be reinvested into the fund, making them eligible for tax benefits. However, the growth schemes under ELSS do not provide these benefits. 

Benefits of these mutual fund schemes 

The tax saving mutual funds provide you with multiple benefits, like making your investment eligible for tax benefits upto Rs.1.5 lakh. Furthermore, the capital gains that you make from these funds in the long run are devoid from taxes. You can also make investments in monthly instalments through SIPs, which would ensure that you do not incur a heavy financial burden while making the investments, and negating the need for a lump sum investment initially. 

These funds are also highly diversified, which means that your investments are considerably safe from the market fluctuations because of the risk being spread across several verticals. Although you cannot withdraw the principal before the lock-in period ends, you can still choose to withdraw the dividends. Nevertheless, in case you choose to not withdraw the investment, it will form a substantial corpus which you can later utilise to fulfil your financial goals and needs.  

Now that you have a fair idea of how you can save tax using mutual funds, and the benefits that they present to you, you can choose to make investments and start your financial journey. However, it is imperative that you always consider the opinions of your financial advisor before making any investment decisions. 

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Mistakes to Avoid to Grow your money through SIPs

May 12, 2022

One of the most common methods of growing your wealth is through a Systematic Investment Plan or SIP. As the name suggests, an SIP means saving small sums of money over a period of time, which ultimately results in you ending up with quite a large corpus. An SIP is one of the most convenient investment vehicles that lets you accumulate a considerable amount of wealth in the long run. 

In order to ensure that you make the most of your SIPs, and grow your wealth to its fullest potential, there are a few basic things that need to be taken care of. Let us discuss some of the common mistakes made by investors that you need to avoid to make the most out of your SIP. 

Do not set unrealistic goals 

One of the most important things to consider when making an investment decision is to set a goal. Having a definitive goal will give you clarity on several factors, like the tenure of your investment, the number of instalments you have to pay, the target amount, and the time it would take you to fulfil your goal.  

Having goals that cannot be monetized within the given time frame makes the goal unrealistic, which can harm your goals and lead you to make investment decisions that are not right for you. Setting a goal that is achievable and suitable for you according to your income and tenure will help you choose the right SIP. 

Increase your SIP investment amount 

It is always advisable to make investments in an SIP, or any investment, for that matter, based on your income. It is also important to increase your contributions as your income and surplus increase year on year. As you move ahead in your career, your income increases, which results in a better, more expensive lifestyle. Over the course of time, it is crucial to ensure that your investments also increase along with your expenses so you can maintain the same quality of life.  

Increasing your SIP contributions over time ensure that your corpus grows and you are able to derive the maximum benefit through compounding and reap the  maximum possible returns on your investment. 

SIPs & market fluctuations 

It is always advisable that you invest in equities in the long term. Equity funds perform the best when there is a long-term timeline along with a proper target amount. However, the market is meant to be volatile and market fluctuations are a part of the investment journey. You should never cancel your SIP during periods of market correction since it can have a negative effect on your investment. While planning your SIPs, you should have a somewhat flexible timeline that lets you accommodate for market fluctuations. During the ups and downs of the market, remain patient instead of cancelling your Systematic Investment Plan. 

Review your SIP performance 

Investing in an SIP is one of the first steps of your investment journey. Therefore, you need to monitor the investment from time to time, to ensure that your long-term goals are in sync with your SIP. 

It is important for you to review your SIPs to help you understand which of your mutual fund schemes have performed according to your expectations and which haven’t. If you find that one of your schemes has been underperforming for the last 18-24 months, you may choose to exit the scheme. 

Furthermore, if you monitor your SIPs periodically, you also get an idea of how to rebalance your portfolio depending on your asset allocation. 

Invest early 

You can invest in an SIP at any point in your life, but it is advisable to start investing as early as possible. Investing early ensures that you get the chance to accumulate a higher corpus, and have a high wealth ratio. Even if you have a lower contribution margin, provided you start early, you have the chance to maximise your returns through the power of compounding. The power of compounding ensures that your principal earns returns, and your returns earn returns. The earlier you invest, the more time you leave for your principal to compound. 

Have a disciplined approach 

When investing in an SIP, it is important to understand that you have to remain invested until the investment tenure is over. In case you choose to leave the SIP, you may not be able to fulfil your financial goals. Therefore, it is important to be disciplined when making contributions to the SIP. 

Before you start your investing in your SIP, you should decide on an amount that is feasible for you, after you meet your regular financial obligations. You can use an SIP calculator to estimate if an SIP will be able to fulfil your investment needs based on your budget, your risk tolerance and the tenure of your investment. It is important that your investment amount is not extremely high, leaving you enough room to navigate your regular expenses. 

Following these easy, but important steps ensures that you make the most out of your SIPs. However, always understand that these investments are subject to market risks, and you should always consult your financial advisor before making a financial decision. 

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How does determining your investment objective indicate your risk profile?

May 9, 2022

All investments carry with them a disclaimer that states that returns are subject to market risks. Investing in the market carries with it a certain element of risk, and you must understand these risks before you make any financial decision. While it is important to make investments to fulfil your financial goals, it is crucial that  you understand the risks to avoid any mistakes that may set you back. Your risk profile indicates the kind of investment vehicle you should choose, and your investment objective determines your risk tolerance.

Let us first understand what a risk profile is, followed by how your investment objective can determine the risk profile you’re a part of.

What is a risk profile?

A risk profile can be defined as your willingness or tolerance toward taking risks. Creating a risk profile is an imperative process towards determining the right investment asset allocation in your investment portfolio. It enables you to identify the acceptable amount of risk that you can endure. In this particular case, risk refers to your tolerance to market fluctuations and volatility.

If you’re looking for your principal investment amount to not decline, and are willing to let go of potential capital appreciation in this process, you have a low willingness to take on market risks, and hence have low risk tolerance. On the other hand, if you desire to make the highest possible earnings from capital appreciation, and are willing to take the chance that your principal investment amount may decline if a particular investment may not pan out, you have high risk tolerance.

Your ability to take risks is determined by reviewing your liabilities and assets. If you have more assets than liabilities, you can take more risk, and vice versa. However, your will to take on risks and your ability to sustain them might not always match up. For example, you may have a lot of assets, but are of a conservative nature, and showcase a low desire to take on risks. In this case, the ability and the willingness to take risks are different, which affects the portfolio construction procedure.

Now that we have a fair idea of what a risk profile is, let us understand the factors that determine your risk appetite.

Factors that dictate your risk appetite

Prior Experience: Just like you become better at a sport, or any other task with practice and experience, you gain more experience as you continue investing in the market. Your knowledge of investment products, market trends, your last portfolio, and its performance are all key factors that  are included in your past experience. These experiences make you a veteran investor and can impact your risk appetite.

Present Scenario: Your present age, financial liabilities, income sources, and engagement levels are key determinants of your risk tolerance. If you’re a young investor with no financial liabilities, you can have high risk tolerance. On the other hand, if you are a middle-aged man with a family, you’re unlikely to take heavy risks with hopes of high returns.

Investment objectives: The most important factor that determines your risk appetite is the reason why you started your investment journey and why you’re continuing the same.

How does determining your investment objective indicate your risk profile?

You can begin investing for a plethora of reasons, and every reason has a different mode of investment suitable for fulfilling the objective. From wanting to go on an international vacation, to buying a car, to a retirement plan, everything can be a reason to start investing. Depending on your investment objective, your risk profile can be indicated.

For instance, if you’re starting your investment journey to create a stable retirement plan, it is unlikely that you will undertake huge risks and be an aggressive investor. In this case, you would rather invest in funds that provide consistent market returns despite any fluctuations.

What are the types of risk profiles?

There are three broad brackets in which risk profiles can be categorised into. Based on this categorization, you can identify which profile you come under.

Conservative: A conservative risk profile indicates an investor with a low risk tolerance. If you’re a conservative investor, you will be inclined towards investment methods that are safe and protect your principal corpus. Returns on investments are secondary as long as your investments do not depreciate.

Moderate: If you’re a moderate risk taker, you tend to strike a balance between risk and reward. You would opt for a high returns scheme on an acceptable risk level, but you’d probably skip anything with extremely high risk elements.  

Aggressive: This particular risk profile showcases the most willingness towards withstanding market fluctuations, aiming at high returns on their investments. Usually, this profile constitutes veteran investors who are well versed with the market and investing intricacies. Moreover, these investors also have long-term plans, which is why they are okay with absorbing any short-term market fluctuations.

All being said, fixing your investment objective can help you analyse your risk profile better, and no matter what risk profile you consider yourself to be, you should always consult your financial advisor before making any financial decisions.

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