Your asset allocation decision begins with your financial plan. Your plan typically allocates a certain percentage of your corpus to equity funds and a certain percentage to debt funds. The bigger challenge lies in actually boiling down to which scheme to invest in. There are over 30 AMCs in India and hundreds of equity and debt schemes with subtle differences in terms of growth, dividend and reinvestment options. How to zero in on the right equity and debt scheme for your requirements? While there are no hard and fast rules, here is a quick guide on how you can go about selecting the right fund.
Is the fund in sync with my goals?
As part of your financial plan you have short term goals in terms of liquidity and tax efficiency and long term goals in terms of risk and returns. For example if your investment in debt funds is supposed to provide liquidity, then no point in locking into a fund that invests in corporate debt that tends to be illiquid. A G-Sec fund will make more sense in this case. Also, in terms of taxation, an equity fund is more tax-efficient as compared to a debt fund; both in terms of dividends and capital gains. Long term risk and returns are critical in this choice. If you want to plan for your long term needs, you should typically prefer diversified equity funds over sector or thematic funds. Themes and sectors may go through cycles, whereas diversified equity funds can offer a better handle on risk. Therefore your long term and short term goals become a critical standpoint from which to evaluate your choice of fund schemes.
Past may not be king, but is a good indicator…
When it comes to investing, past performance need not necessarily be indicative of the future. But that is the closest you can get to having comfort level with respect to a fund house or a scheme. If a fund has outperformed the market over the last 5 years, it is highly unlikely that the particular scheme could grossly underperform the market. Consistency and low standard deviation is more important when evaluating a fund. Average return by itself can be misleading as low standard deviation or volatility is more important when you are selecting funds for your financial goals.
Give more credence to long period returns than short period returns…
Don’t give too much importance to outperformance over a period of 6 months or even 1 year. That is hardly the time frame you are looking at. Consistent performance over a period of 3-5 years is more important as that is good enough to smoothen the peaks and troughs of an equity cycle. Even in case of debt funds, don’t give too much importance to funds that outperform in a falling interest rate scenario. That is a dud’s game. It is times of volatile interest rates and volatile debt markets that separate the men from the boys.
Don’t put all your eggs in one basket…
Typically, many investors are worried about how many fund schemes they should be exposed to. In the interests of diversification, it is always advisable to be exposed to more than one scheme. We all saw last year how J P Morgan’s debt fund was inordinately exposed to the debt of Amtek Auto. That resulted in the fund’s NAV plummeting and the fund almost being forced to freeze redemptions. That is the risk when you are overexposed to just one fund. Try to spread your money across 3-4 different schemes for each theme. Avoid the risk of over-diversification. If you spread your money across 12 different schemes, you will not derive any additional benefits of diversification nor will you be able to track these schemes.
How much is the Fund taking away?
Every mutual fund has a certain cost of running and operating the fund and that is debited to the fund and results in reducing the NAV. While this is acceptable, compare different funds on the basis of their cost to you. Typically, the total of management fees and annual operating costs vary in the range of 1.5-2% on an annualized basis. This becomes more significant in case of debt funds where the annual returns will be in the range of 8-10%. Hence, even a difference of 20-30 basis points can make a vast difference to your annual yield.
Selecting a fund is an important part of the financial planning process. Your job does not end with selecting the fund. You also need to constantly track that the fund’s philosophy and portfolio mix is in tune with your financial goals. Otherwise, it is time to make a switch!
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