For a beginner, the most complex thing is choosing the right mutual fund. Investors who are new to investing often get confused with balanced funds, debt funds, equity funds, FMPs, Gilt Fund and so on. Let us see how to choose the right mutual fund for you.
Age group is important
If you are younger in your 20s and 30s it makes sense to deploy large amounts of money into equities, as you have the ability to take risk and hold onto shares for longer in case there is a sharp reversal in equities.
Let us say you were in your 30s when there was the Lehman Brothers crisis and the markets went into serious downside that lasted for years after 2008.
If you were young and were able to stay invested for the next 10 years or so, in 2018, you would have created solid wealth. So, if you are younger it makes sense to deploy at least 80 per cent in an equity mutual fund and the balance in a debt mutual fund.
Ability to take risk
It also depends on your ability to take risk. Some individuals by nature do not have a penchant for risk.
In such cases you must almost always place your money into debt mutual funds. However, now with even equity mutual funds being taxed, debt mutual funds have become a better proposition.
The tax benefits on debt mutual funds could be much better than bank deposits, especially if you are in the higher and the highest tax brackets. Here again you have various debt options. The safest of course is the Gilt Edged funds, which tend to place all the money in safe government security.
If you are looking at medium risk, you can go for a balanced fund that parks money in both equities and debt. Again, you need to study the entire objective of the fund very carefully and see the extent that is deployed in equity and shares. Normally a sum of 60 to 65 per cent is deployed in shares and the balance in debt.
Also, it is important to remember that with 34,000 on the Sensex the markets have rallied quite a bit and hence it makes sense to move money from pure equity funds to balanced funds or debt funds.
Also, study your own tax liability before investing in mutual funds. In the Union Budget 2018, the income distributed by mutual funds have been bought under tax, which means equity mutual funds, which all along have been a preferred destination have now been bought on par with debt funds, where there was always a tax liability.
If you are in the highest tax bracket it makes sense to park money into mutual funds, as returns are better post tax, when compared to bank deposits.
These days with tax introduced on distributed income of equity mutual funds, these can now be well compared to debt mutual fund schemes.
Avoid small cap funds if you cannot take risk
If you are unable to take large risks, it is better to avoid small cap and midcap funds. In the last one year these funds have given stupendous returns, but, we are now seeing some serious declines.
This is because, if there is a sudden fall in the market these stocks tend to fall faster than the markets, which make them a very risky proposition.
Overall, you might want to stick to the largecap funds or balanced funds. If you are looking for high safety stick to the Gilt Funds, which invest bulk of their money in safe government securities.
Move between funds
It is also a good idea to switch between funds to maximize your returns. For example, if you realize that the equity markets are hitting successive peaks, it makes sense to move money from equity to debt. On the other hand when interest rates are falling, it makes sense to move money into equities.
At the moment we are seeing that inflation has started creeping in and investors are slowly moving money to debt as bond yields rise. In fact, rising bond yields are now pushing global stock prices much lower than before. So, you need to adopt a dynamic approach, though switching in between is not advisable very often.
Once a year should be good enough.