Mutual Fund for beginners cheat sheet for Financial Success

We’ve explored most aspects of Mutual funds, which brings us to the ultimate challenge: constructing a portfolio. It’s been a long process to come up with the best method of explaining this complex subject, but I think I’m up for the task!

I’ll tell you the reason soon, but don’t fret, I will try to make it clear.

Before proceeding, I need to clarify a few presumptions I have made.

When discussing building a mutual fund or stock portfolio in order to achieve a financial target, two possibilities must be considered:

• We are covered for the risk
• We are covered for emergency

Before a person can have a portfolio of any sort, these two things should be in place.

Let me explain what I mean.

Cover for the risk – An individual is faced with a wide range of risks throughout their lifetime, including physical and mental health, permanent disabilities, extended periods of unemployment, and broken relationships.

 While it’s not feasible to foresee everything, it is essential to have protection for two major aspects of life: death and hospitalisation. Taking out a policy can be a safeguard against such eventualities.

Of course, insurance provides the necessary cover. In the event of your passing away, term insurance guarantees that your dependents are not financially disadvantaged.

Health insurance can protect your life savings from being used up to pay for medical bills when managing a chronic condition.

It’s important to assess the amount of money your family will receive in case of your death and determine the level of health insurance coverage you need. Insurance is an expansive subject, full of technicalities, so I won’t dive into details at this time. However, as a person embarking on a personal finance journey, the initial step should be getting protection for both types of risks.

It is highly recommended to avoid insurance products linked to investment plans, as they lack value.

Cover for an emergency – Covering yourself for emergencies is essential; whether it’s joblessness, a broken appliance, or a medical expense, having a contingency fund to fall back on could be the solution.

I understand medical emergencies are generally covered by health insurance, but it’s important to keep that in mind. For instance, when my parents were struck with Covid 19 back in September 2020, the hospital required me to pay an admission fee and cover some of the initial costs. Fortunately, I had an insurance policy for them both which paid out afterwards; however, I had to have ready cash there at the time which required a large sum.

Due to Covid 19, schools shifted to digital platforms, so I had to purchase a laptop and printer for my 10-year-old daughter. It was an unforeseen cost, but it couldn’t be helped.

Emergencies may happen unexpectedly and at any time. To be equipped for these unexpected events, it’s best to start your personal finance journey by establishing an emergency fund. Having the necessary funds readily available will help you manage the situation better when it arises.

The emergency corpus varies from person to person, but many agree that it should be equivalent to 6 months’ worth of expense. For instance, if your monthly expenditure is 40K, then 2.4L would be a suitable amount to have set aside.

But I don’t subscribe to the 6-month emergency corpus template.

Each individual and family is unique, so it may be beneficial to discuss potential solutions that would help your household make it through this challenging period. Decide on a sum of funds that will provide a sufficient cushion for those involved.

Assuming you own basic insurance and have created an emergency corpus, let’s learn how to construct a mutual fund portfolio.

Financial Goal

Imagine a newlywed husband and wife. Both of them are in their late ’20s, employed and driven to acquire a 2BHK apartment downtown, costing approximately 1.5Cr within the next decade.

Contemplate this example: A 40-year-old working lady is aiming to save enough money in the next five years to purchase a vehicle worth 55L.

Suppose a 21-year-old has recently acquired employment in an MNC and would like to save up 20L in 8 years for their postgraduate degree in the UK.

These are all examples of a ‘financial goal’. A financial goal has three specific attributes –

• The quantum of funds required
• The estimated time over which these funds need to be accumulated
• The current age of the person

Without these three attributes, a financial goal is incomplete.

A young working professional who is looking to go to the UK for post-graduate studies a couple of years from now, setting the goal of accumulating ‘enough money’ is not reasonable.

The three random scenarios I’ve mentioned illustrate how unique and varied everyone’s financial goals are. Apart from retirement, there’s rarely any overlap in the needs of two different families or individuals. Financial objectives are incredibly personal to each person’s circumstances.

No matter the challenge, it is beneficial to consider mutual funds as a solution in many scenarios.

In addition to other financial tools, mutual funds and exchange-traded funds are particularly useful for their flexibility.

This situation presents two possibilities for me to show you how to assemble a mutual fund portfolio that meets your financial aims.

• Contemplate life scenarios, generate case studies, and craft a mutual fund portfolio to address the problems presented. Analyze the circumstances and spot which one fits closest to your current situation. Subsequently, assemble a similar portfolio for yourself. Or
• Understand the portfolio aspects of numerous funds, to decide which are most suitable for your situation.

The contrast between these two approaches is like this – if you’re partial to savoury dishes, I give you 20 options to sample. Once you’ve had a taste of each one, it’s easy to decide which one you want to enjoy wholeheartedly.

I will acquaint you with ten essential savoury ingredients. With a sufficient knowledge of these items, you can effortlessly craft a scrumptious meal to delight your palate.

I’m opting for the second option to construct a mutual fund portfolio, hoping it’ll prove a more successful endeavor.

Mutual Fund cheat sheet

This Mutual fund cheat sheet will be very useful to you. It’s a summary of all the essential aspects of the various mutual funds we discussed. To get a better view, click on the image and it will enlarge.

The table is simple, has few basic information –

• Fund type
• Category
• The main constituents of the fund
• Expected CAGR
• The minimum holding period – the minimum holding period for the fund if you were to invest in it. Not that you cannot invest in the fund and hold it for lesser than the minimum holding period, it is just that if you do so, recovering from a drawdown could be difficult.
• Financial Goal – The kind of financial goal the fund can be used for, more on this later.
• ‘Special remark’ – Things you need to be aware of.

I’d suggest you keep this table handy. This table will help you craft a mutual fund portfolio for most of the financial goals.

Before venturing on, it is important to consider the number of funds required in a portfolio.

Often, investors have 10-12 mutual funds in their portfolio for a single financial goal. Generally, they comprise 3-4 large-cap funds, the same number of mid-cap investments, numerous debt funds and maybe even a hybrid fund.

This is a classic example of a messy, directionless, and a pointless portfolio.

Ideally, you need to have non-overlapping mutual funds to avoid redundancy.

Let me explain, assume you have the following three large-cap funds in your portfolio –

• Axis Bluechip fund
• Mirae Asset Large cap fund
• Canara Rob Blue chip Equity.

It is advisable to look at the top 10 holdings across all three funds before deciding whether or not to add them to your portfolio. Although all three are good, it is still possible that one or more of them may not be suitable for you.

It’s evident that a lot of the funds’ portfolios are alike; HDFC Bank is held by all funds up to 10%. Expanding this analysis to the entirety of their holdings probably uncovers much higher commonality. This in turn probably results in similar performances and volatility due to economic/market factors being comparable.

By investing in multiple funds of the same type offered by different AMCs, you will not gain any substantial benefit.

The only rationale behind investing in two funds of the same type is diversification; this involves spreading your money between two different AMCs. This course of action might be beneficial if you are concerned that one of them could go out of business while your investment is held.

The ideal solution is to try including a variety of funds from different Asset Management Companies (AMCs), like a large-cap fund from HDFC and a mid-cap fund from DSP, in order to diversify your investments across AMC’s and market capitalizations.

As an investor, it is important to build your portfolio so that the overlap between funds is minimised. It can be tricky to achieve this, but doing so will prevent you from paying for the same exposure and therefore help to maximise your returns.

Portfolio, by the method of elimination

Let us go back to the examples we discussed earlier and analyze how this table could be used to design a mutual fund portfolio.

Case 1 – A newly married couple are aiming to purchase an apartment valued at 1.5Cr in 10 years. Both of them have jobs, they can save 30K a month.

We have the following data –

1.     Savings per month – 30K each
2.     Target corpus – 1.5Cr
3.     Time available – 10 Years
4.     Age – Young can afford to take financial risks in life.

Let us employ the removal method to reach our portfolio. I believe this approach is extremely powerful; it can help eliminate any wrong funds from our financial goal.

We have a 10-year time horizon, so investing in debt isn’t necessary. Let’s take out the debt component.

When I say debt is not necessary, I want to emphasise that it should not be the primary source of capital. I’ll revisit this topic shortly. Debt has another purpose here.

The focus is clearly fixed on Equity as the category; now we need to start narrowing down the list of schemes from this category.

• Large & Midcap – may not work, since most of these ‘Large & Midcap funds’ are mid-cap stocks anyway.
• Small-cap funds – These are risky, volatile. Of course, ten years is a good enough period for this fund, but I’d personally avoid given the quantum of volatility involved in these funds.
• Multi cap funds – These are again qazi mid, and small-cap stocks, may as well stick to a straight forward mid-cap fund.
• Focused fund – Focused funds provide investors with a highly concentrated bet, and require the fund manager to have top-notch skills; if they err in their choice, it could be too late before they realize.
• Thematic funds are sector-related; if the sector does not perform well, it could take a long time for the fund to recover.
• ELSS funds – ELSS funds offer the opportunity to save on taxes while achieving one’s financial goals.
• Index funds – Index funds are a great option for long-term financial goals like retirement. However, it is important to note that a 10-year period may not provide the maximum benefits for these funds. Therefore, it is best to use them for something that has a hyper long-term outlook.

Reasoning that the alternatives are not acceptable, we can proceed with the following options:

• Large-cap fund
• Mid-cap fund
• Value fund

Given the potential risks linked with value stocks, I would strongly advise against investing in them. As such, it would be most beneficial for the couple to invest in both large and mid-cap stocks.

Both of them can choose a fund in either category and begin investing. As we have mentioned before, the previous chapters explain how to pick an equity mutual fund.

SIPs are a great way to invest in mutual funds: by regularly putting aside a fixed amount every month, you can create an investment portfolio tailored to your needs.

It is evident that with a CAGR of 10%, the numbers can look impressive. The calculation table below should provide an insight—it only contains a portion of the data.

I’ve taken a CAGR of 10% for large-cap and mid-cap funds, which could be seen as either aggressively or conservatively optimistic. Let’s not expand further energy discussing it though.

As can be seen, the couple has accumulated near 1.21Crs, which is only a bit away from the target funds over the 10-year period. A bank loan could fill in this insignificant gap.

Considering another angle, what if you get closer to the target year and the market takes a downturn, causing your capital to be reduced? As much as we all may wish otherwise, nobody can predict a market’s behaviour.

As the target year approaches, one strategy to consider is shifting corpus funds into a debt fund. Starting from the eighth year, money can be taken out and put in a particular fund that offers opportunities for growth. There are many different options available for this endeavour.

• Withdrawal can be made on a monthly/quarterly/semi-annual basis.
• The funds withdrawn, can go into an ultra short term fund since we only hold the funds for 3 years.

The idea here is to protect the corpus from a sequence risk, where in the market takes a hit as and when the target year approaches.

Of course, this is a rather simplified approach, but I’d like to keep it simple and not over complicate it.

In this instance, you may be wondering whether it is a ‘fill it, shut it’ strategy with no involvement in the investment journey. This is essentially a hands-off system, however from time to time – such as on an annual basis – one should monitor the fund’s progress and make a decision about carrying on.

Apart from that, you need to keep these two points in mind –

• When handling personal financial returns, it’s wise to err on the side of caution. In the event that you end up with more than expected, consider it a fortunate outcome.
• It’s clear that equity returns are lumpy, not consistent like bank FD returns. You may experience a long period of no returns, however, you can expect the majority of the gains to come in short bursts. Unfortunately it is impossible to predict the timing of these bursts, so setting up a SIP and giving it enough time is key.

Let’s analyse another example to understand how eliminating investments can add value when constructing a Mutual Fund portfolio.

Case 2 – A 40-year-old has a savings goal of Rs.25L, to be achieved in the next eight years, for their children’s overseas postgraduate degree. They have Rs.20,000 in monthly savings available to put towards this.

Since the time period is under a decade, there is no need to consider 100% equity investment. Instead, the strategy should involve mostly debt with possibly a negligible equity part.

Ok, to begin with, let us keep Equity aside for now and look at the rest of the funds.

Hybrid funds such as the Arbitrage fund may be a wise investment, while a balanced fund may not be the best choice.

Debt funds are a good option –

• Liquid funds and overnight funds won’t fit the bill since we are talking about eight-plus years
• All funds with Macaulay duration of fewer than two years can be ignored since these are relatively shorter maturity funds.
• Money market funds too can be ignored since the investor can take on a slightly higher degree of risk
• A short-duration fund is an option
• Credit risk is risky so that they can be avoided.
• Corporate bonds fund is an option
• GILTS won’t fit the bill either.

This leaves us with three good options –

• Arbitrage Funds
• Short duration funds
• Corporate bond funds.

Investing in a corporate bond fund requires considerable dedication from the investor. It is essential to monitor the scheme’s portfolio regularly, and if this isn’t achievable then two options remain: investing in a short duration fund or an arbitrage fund. Splitting the investment evenly across both might be the optimal solution.

Something to remember – just because the investment is in a short duration fund and an arbitrage fund, that doesn’t mean review of the fund’s portfolio isn’t necessary. Though it won’t require as much attention as a corporate bond fund might call for, one should still take the time to look it over at least every three months. The same goes for an arbitrage fund, considering its debt component.

No need to trouble yourself with the maths, but if 7% annual growth is assumed, then the target funds can be accumulated over the given duration.

Given the length of this commitment, one may want to look into a modest equity exposure. Perhaps 20-25% of the monthly SIP can be put in a large-cap fund.

Let us consider another example: You’ve recently acquired a large sum of money, say Rs.50L, from the sale of a given asset such as real estate. You are eager to use these funds to start funding for retirement, but you are worried about the current market climate and fear that it might not be sustainable.

Retirement is a long term financial goal that could span more than 20 years, depending on your current age.

Here is a plan assuming you are not comfortable investing the lump sum right away.

• Invest the lump sum in a fund which offers capital protection (to the best possible extent)
• Withdraw chunks of it every month and invest that into the designated fund for retirement
• Continue doing do so till you deploy the entire capital

In this case, you can decide to invest 50L over 3/6/12 months, based on your comfort.

Assuming, six months, then every month you will invest –

5,000,000/6

= 8.3L.

The question is, what is the choice of funds for such a plan of action.

• We need a carrier fund, which will hold the capital, provide adequate capital protection over the next six months.
• The only funds which fulfil the purpose of the carrier funds are – the overnight or liquid fund.
• Identify a target fund for retirement. Recall, retirement is a hyper long-term financial goal so the funds you pick for this purpose should fit this bill
• The best funds for retirement (in my opinion) are Index funds, large-cap funds, or just a balanced fund.

So the set up here would look like this –

• Park the entire 50L in a liquid fund to redeem the entire amount over six months
• Redeem 8.3L every month from the liquid fund over the next six months
• Invest the funds redeemed funds into the retirement fund – say a Balanced Fund and a Midcap fund. Or an Index fund and a mid-cap fund.
• If you are choosing two funds, the funds can be split equally.

Once you invest in these funds, the only thing you will need to do is check-in occasionally. Make sure to keep an eye on a few things;

• Every year, make sure your fund is not trailing behind its peers, and that it is not exhibiting an excessive degree of volatility compared to other funds in the same category.
• You may want to realign your investments according to your risk appetite, making profits from equity funds and investing the money into debt funds.

Apart from the two mentioned, you should be all set. Under no circumstances should you try anything else; just let the market work it out.

I’ve tried to give you a solid foundation here on how to go about constructing your mutual fund portfolio. I could have gone into more detail, but this should be enough to get you started.

I’m interested in exploring the concept of goal-based investing, however I‘m not sure if I will pursue this path. If you feel I should, please let me know your thoughts in the comments section!

In the following sections, I would like to talk about SGBs, NPS and asset allocation. Then, at the end of this module, I will provide a summary.