Mutual Funds: Smart Investment Strategies For Financial Goals

Mutual funds are a popular investment vehicle for those looking to diversify their portfolios. They pool money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities. This provides individual investors with access to a professionally managed portfolio, potentially benefiting from economies of scale while spreading risk across multiple investments.

Before investing in mutual funds, it is essential to identify your financial goals and risk tolerance. Different types of mutual funds cater to various investment needs, timelines, and risk appetites. Here are some common financial goals and suitable mutual fund options:

- Retirement planning: Diversified equity mutual funds, such as large-cap, multi-cap, and small-cap funds, are suitable for this long-term goal. Systematic Investment Plans (SIPs) can help take advantage of compound interest and ride out market volatility.

- Children's education and marriage: Large-cap funds, index funds, and hybrid funds are appropriate for these goals, which usually have shorter timelines than retirement planning. Gold funds can also be considered for children's marriage.

- Short-term savings for vacations, vehicle, or home purchases: Low-duration or short-duration debt funds are suitable for goals within 1-2 years. Liquid funds and ultra-short-duration funds are ideal for goals less than a year away, while long-duration debt funds or dynamic bond funds can offer higher returns for goals 3 years or further away.

- Tax savings: Equity-Linked Savings Schemes (ELSS) offered by mutual funds can help claim tax deductions under certain sections of the Income Tax Act.

- Regular cash flow/income: Mutual fund Systematic Withdrawal Plans (SWPs) provide a tax-efficient solution for retired investors who need regular cash flows from their investments. Hybrid funds are a good option for SWPs as they balance risk and return.

When investing in mutual funds, it is crucial to understand the fees involved, such as expense ratios, load fees, and management fees, as these can significantly impact your overall returns. Additionally, consider the investment strategy, past performance, and your level of comfort with risk. Mutual funds are generally a long-term investment, and it's important to assess your financial goals and risk tolerance before committing.

Retirement planning: Consider large-cap funds, multi-cap funds, and mid-cap funds

Retirement planning is a crucial aspect of personal finance that requires careful consideration and strategic investment decisions. Mutual funds can be a key part of any retirement plan, offering long-term growth potential and diversification benefits. When it comes to retirement planning, here's how large-cap funds, multi-cap funds, and mid-cap funds fit into the picture:

Large-Cap Funds:

Large-cap funds focus on investing in the largest companies, typically those with a market capitalization of over $10 billion. These funds offer stability and are ideal for conservative investors as they have a relatively lower risk profile compared to other equity funds. Large-cap funds are known for their blue-chip companies with established business models and strong financial positions. They are a good choice for investors seeking long-term growth while minimising risk.

Multi-Cap Funds:

Multi-cap funds, as the name suggests, invest in a diversified portfolio of large-cap, mid-cap, and small-cap stocks. These funds are mandated to invest at least 25% of their assets in each of the three market cap segments. This means that multi-cap funds offer exposure to a broad spectrum of companies across different market capitalisations. They are suitable for investors seeking diversification and a balanced portfolio. Multi-cap funds are actively managed and can adapt to changing market conditions, making them a good choice for long-term investors.

Mid-Cap Funds:

Mid-cap funds focus on investing in medium-sized companies, typically with a market capitalisation between $250 million and $2 billion. These companies tend to be newer and carry more risk compared to large-cap stocks. Mid-cap funds offer higher growth potential and are suitable for investors with a higher risk tolerance. They are a good choice for investors who want to balance their portfolio by adding some riskier assets with the potential for higher returns.

When incorporating large-cap, multi-cap, and mid-cap funds into your retirement planning, it's important to assess your risk tolerance, time horizon, and overall investment objectives. These funds can provide diversification, growth potential, and in some cases, professional management. It's also crucial to consider the fees and expenses associated with these funds, as they can impact your overall returns.

Children's education and marriage: Large-cap funds, index funds, and gold funds are suitable

Children's education and marriage are long-term investment goals that require proper financial planning. Large-cap funds, index funds, and gold funds are suitable investment vehicles to achieve these goals. Here's how:

Large-cap funds invest in the equity and equity-related instruments of well-established companies with large capitalisation. These funds are known for generating steady returns and are less risky compared to small-cap and mid-cap funds. By investing in large-cap funds, you can benefit from the stability of investing in established companies, which are better equipped to sail through bearish market situations. While the returns may not be as high as those of small-cap funds, large-cap funds offer a more conservative investment strategy with lower risk. This makes them suitable for long-term goals like children's education and marriage.

Index funds, on the other hand, are passively managed, meaning they seek to track and duplicate the performance of a benchmark index. These funds have lower fees because there is no active fund manager making investment decisions. The savings over time can be significant. Index funds also allow you to stay committed to the fund for the long term, as they are benchmarks and won't underperform. This makes them a good choice for long-term investment goals. Additionally, you can spend more time on other investing issues, such as asset allocation, rather than trying to pick winning funds.

Gold funds, although not specifically mentioned in the provided text, are also a viable option for long-term investment goals. Gold is often seen as a stable investment, offering diversification and a hedge against inflation. Gold funds typically invest in gold bullion, gold-related securities, or a combination of both. They can provide exposure to the gold market without the need for physical gold ownership.

When investing in mutual funds for children's education and marriage, it is essential to consider the investment horizon, risk tolerance, and potential returns. These investments usually have a long-term horizon, and it is recommended to select schemes wisely, keeping the long-term benefits in mind. Additionally, assessing your risk profile is crucial. Large-cap funds are generally considered less risky, while small-cap funds offer higher returns but come with higher risk.

To start investing, you can choose between offline and online modes. Offline mode involves visiting the branch office of the fund house or investing through a broker, while online portals offer a hassle-free way to compare and invest in various funds.

Short-term savings: Low-duration funds and short-duration funds are good options

Low-duration funds are open-ended debt schemes that invest your money in short-term debt securities. The Macaulay duration of these investments is between 6 and 12 months. Low-duration funds are suitable for investors who are willing to take on a low level of risk and have a one-year investment horizon.

Low-duration funds are ideal for investors who want to park their money for 6-12 months. The average returns on your investment would range between 6.5 and 8.5%.

Low-duration funds work on the concept of duration. The duration of a debt fund affects its investment decisions and defines the type and amount of returns earned by the fund. The duration of a debt fund measures the fluctuations in a fund’s value in response to changes in market interest rates. We also refer to duration as interest rate risk. Therefore, the fund value becomes more volatile with higher duration and the associated interest rate risk is greater.

Low-duration funds expose your money to a moderate level of interest rate risk. These funds do not usually hold securities with a maturity higher than 1-1.5 years. Low-duration funds generally outperform liquid funds in terms of returns and have the potential to give better returns than ultra-short duration funds.

Low-duration funds are suitable for investors with a moderate risk appetite who have an investment horizon of more than 3 months. They are also ideal for investors who want regular income and an alternative to bank deposits.

Short-term bond funds are another option for short-term savings. A bond is a loan to a company or government that pays back a fixed rate of return. A bond is generally considered a safer investment than stocks, but it still has risks. The borrower could default, or bond values could decline when interest rates rise.

To reduce the risk of default, choose bond funds that primarily own government bonds and municipal bonds. Many U.S. government bond funds currently lag behind the annual return of high-yield savings accounts. Corporate bond funds, particularly high-yield funds, may return more, but with more risk.

Tax savings: Equity-linked savings schemes (ELSS) can help save on taxes

Equity-linked savings schemes (ELSS) are a type of mutual fund that offers tax benefits to investors. ELSS funds are classified as diversified equity mutual funds, with a minimum of 80% of assets invested in stocks and equity-related securities, and the remainder in debt.

ELSS funds are the only kind of mutual funds eligible for tax deductions under Section 80C of the Income Tax Act, 1961. By investing in ELSS, individuals can claim tax rebates of up to Rs 1,50,000 and save up to Rs 46,800 per year in taxes.

ELSS funds have a lock-in period of three years, the shortest among all tax-saving investments, and they offer the potential for high returns. There is no maximum investment tenure, but there is no provision for premature exit during the lock-in period. ELSS funds also have no upper limit on the amount that can be invested. However, the tax deduction is capped at Rs 1.5 lakh, and the tax benefit is only applicable to investments up to Rs 1.5 lakhs per year.

ELSS funds are suitable for salaried individuals who want higher returns than those offered by fixed-income products like the Employees' Provident Fund (EPF). They are also a good option for first-time investors as they provide exposure to equity investing and mutual funds.

When investing in ELSS funds, it is advisable to opt for the Systematic Investment Plan (SIP) route rather than lump-sum investments. SIP allows investors to benefit from rupee-cost averaging, buying more units when the market is down and fewer units when the market is up. This helps to lower the average cost of investment over time.

ELSS funds offer dual benefits of tax deductions and wealth accumulation, making them a popular choice for long-term investors.

Regular cash flow: Systematic withdrawal plans (SWP) are a tax-efficient solution

Systematic Withdrawal Plans (SWP) are a great option for investors who want to create a regular cash flow from their investments. SWP is a facility extended to investors, allowing them to withdraw a fixed amount from a mutual fund scheme at regular intervals.

A Systematic Withdrawal Plan works in the opposite way to a Systematic Investment Plan (SIP). While a SIP allows an investor to invest a fixed amount at predetermined intervals, an SWP allows an investor to withdraw a fixed amount at predetermined intervals. The investor can choose the amount, the frequency, and the duration of the SWP according to their needs. Withdrawals through SWP are subject to exit load, if applicable.

Who can choose to invest in a Systematic Withdrawal Plan?

Any person who has invested in any of the open-ended schemes of a mutual fund can choose to start an SWP for a regular cash flow, subject to a lock-in period, if any.

• The rate of return applied to the SWP is based on the performance of the selected fund.
• The rate of return applied to traditional savings instruments, such as bank fixed deposits, is often lower than that of mutual funds.
• There is no TDS on the SWP amount for resident individual investors.
• Capital gains tax will be applicable as per the type of scheme and the amount of withdrawal.

Effective uses of an SWP

• Creating a regular source of secondary income: Investing in mutual funds and withdrawing via an SWP is a great way to create a regular source of secondary income to tide over the rising cost of living.
• Create your own pension: Regardless of whether you have a pension plan or not, you can create a corpus around five years before retirement and invest it in a mutual fund scheme according to your risk tolerance. Once you retire, you can start an SWP and create your own pension.
• Protect your capital: If you are averse to taking any risks with your investment, you can initially invest in Arbitrage Mutual Fund Schemes, which offer assured returns with near-zero risk. You can opt for the dividend option and invest the dividend in a debt scheme using an SIP. Eventually, you can start an SWP and earn regular income without risking your capital.

Frequently asked questions