Let’s say you fall sick and you visit a doctor. Without telling anything about your symptoms, you simply tell the doctor to prescribe you the “best medicine”. Sounds weird, right? You won’t do it this way. First you will tell the doctor about your symptoms or problems. The doctor will further investigate a few other things from you before prescribing any medicine or treatment. That is because treatment for every ailment is different.
You must be thinking that’s pretty obvious and why am I wasting time in stating the obvious?
Well, the thing is, lot of people simply ask me which is the “best mutual fund” to invest their money in?
This question is exactly the same as asking doctor to prescribe you best medicine without telling your symptoms. If you want to know the best mutual fund, you must know your financial goals. There are literally thousands of schemes in the market and none of the scheme is “best”. Each scheme has got a different purpose and you simply can’t ask for the best scheme. Luckily, all the schemes of mutual funds in India are divided into 36 different categories. Even understanding these categories can help you to a great extent in finding the best scheme for you. You must be like, whattt? 36 categories?!!! Well, you need not worry. Let me make it even simpler in the next paragraph.
Most of the mutual funds can be broadly categorized as either debt or equity. I’ve already covered debt and equity in detail in this article, and how can it help you in determining the right investment scheme. In this article, I’ll take a step further and help you in identifying the mutual fund categories for different kind of goals. For those of you in rush to know the right scheme for you, here is quick guide for you:
- If you have invested in a small cap or mid cap or even large cap fund expecting huge returns in 3 years, you have take a huge risk and you might even lose half of your money.
- If you have invested in a liquid fund or any other debt fund for a goal for 15 years, you are losing a great opportunity of making much higher returns.
If the above intrigues you, keep reading.
Ultra short term goals (0-1 years) - For your goals due within 1 year, you wouldn’t want to take risk of your principal getting lost. Also, you wouldn’t want to pay any exit load while taking your money out from the scheme. For this purpose, Liquid funds, Ultra short term duration, Low duration and Money market fund would be best fits. These are debt funds with most of the schemes not having any exit load. The disadvantage will be moderate returns i.e. 6% to 7% Well, that’s the price you’ll be paying for not taking much risk.
Short term (1-5 years) - For your goals due after 1 year, you will be in a position to take little risk and also invest in schemes having some exit load upto 1 year. Based on how much risk can you take psychologically and financially, the right category for you will differ. For low risk takers, Short duration and Medium debt duration funds will be good. For those who can take risk, can also go for some equity funds in their portfolio via balanced funds, large cap funds or index funds.
Medium term (5-10 years) - When it comes to your medium term goals, you will be in a position to take some more risk. Portion of equity can increase in your portfolio. Low risk takers can have a portfolio of long duration debt funds coupled with large cap funds or even ELSS (which also gives tax advantage). High risk takers can take a step further and might introduce mid cap funds or multi cap funds in their portfolio. Please note that 5 years is still not that long as far as equity funds are concerned. Market can go upside down in 5 years. That’s what the risk is all about. Hence, the portfolio should not be completely into risky equities like mid cap funds even at this stage.
Long term (> 10 years) - Now, when it comes to long term i.e. more than 10 years, you have all the options open for you. Based on how much risk you can take, your portfolio will vary up to a great extent. High risk takers can go with mid cap and small cap funds. Very high risk takers can also include sectoral or thematic funds in their portfolio. If you want to take risk with only debt funds, dynamic bond funds, gilt funds, corporate bond and credit risk funds will fit in to your portfolio. The exact proportion of all these funds in your portfolio will vary with your risk taking appetite and the kind of goals you have. You must consult a financial adviser to devise a portfolio for you.
To keep it little simple, I haven’t covered all the categories here. However, I hope this gives you a broader idea of how to go about selecting the schemes. As I said earlier, If you have been investing in mid cap and small cap funds for short term goals, it’s very risky. You might not be able to fulfil your goal. On the other hand, if you have been investing in liquid funds for your long term goals, you are losing a huge opportunity to make much higher returns in long term.
Category is fine, but which scheme?
Well, to close the loop, category is just not enough. You have to know the exact schemes also. But, knowing exact set of schemes that are best for you is like determining a treatment for you based on your existing health conditions, age, body vitals etc. Since all these things are different for different individuals, the exact treatment varies from individual to individual. In case of mutual funds, the exact set of schemes for you depends on your financial goals, risk taking appetite and existing investments you have. Hence, it will be different for different people. To know that, you need to consult financial doctors i.e. Investment Advisers like us :)