The 3 phases of MF investment

Create, preserve, redeem... No, we are not talking of the cosmic life-cycle but the mantra to manage your mutual fund investments

If you are a newbie investor taking the first shaky steps into the world of mutual funds, you might think that your job ends with choosing the right fund to bet on. The money then compounds miraculously, leaving you with a neat pile when you need it the most. However, this is far from the truth.

The Trinity concept comes in handy when explaining the phases of mutual fund investments and how all three phases play a significant part in helping you achieve your objective.

From creation comes life, and from destruction comes re-creation. Taking a divine cue from Brahma, the creator, Vishnu, the preserver, and Shiva, the destroyer, you must pay equal attention to the creation of your mutual fund portfolios, preservation of the corpus and finally the redemption and deployment of the redeemed funds.

Let’s take a look at the three stages in the life-cycle of a mutual fund portfolio.

Creating the right portfolio

A job well begun is half-done. But before you start buying schemes to build a portfolio, you have to pause and ask yourself two questions. The answers to these questions will define the contours of your portfolio. The questions are:

Why am I saving money? There ought to be specific objectives for which you are saving money in mutual funds. These objectives are called goals in investment parlance.

Setting up goals such as paying for your college fees, buying a car or house, planning for your children’s higher education, your retirement, etc, will help keep you focussed. The goal will further help identify the investment options and to decide the time frame required to achieve the goal.

How much risk am I willing to take? Once the goal is defined, you have to assess your risk profile to understand the level of risk you are comfortable with. Age, employability, nature of job, family background, capital base and regularity of income are some of the factors considered while measuring the risk profile.

Some asset management companies and broking houses like ICICI Pru MF, Kotak MF and fundsupermart provide questionnaires on their websites to help you assess your risk profile.

Choosing the right assets: Once the goals and risk profile are defined, you have to decide on the right assets to invest in. Mutual funds offer an array of options to investors, including equity, fixed income, gold and overseas equity. Depending on your goals and risk profile, select the right mix of assets.

For instance, investors with a reasonable risk appetite could consider investing in equity mutual funds while retirees with low to medium risk profile could go for balanced debt-oriented and short-term debt funds.

You might want to create multiple portfolios, one for each goal. In this case, the time period will determine the asset mix. For instance, if you are saving for your son’s higher education and want the money in five years, you might want to park the money in a mix of equity and debt funds.

The future value of the corpus depends on the right asset allocation. Each category has its own risk return profile. The equity mutual fund categories — sector, thematic, large-cap, mid- and small-cap, and multi-cap funds — are high-risk high-return products suitable for investors with high risk profile and for long-term financial goals. Fixed income categories such as liquid, ultra-short term, short-term income, long-term income, credit opportunities and gilt funds are suitable for investors with low to medium risk appetite.

A 30-year-old investor with a high risk profile can allocate 70-80 per cent of his long-term portfolio into equity diversified funds with the rest in balanced and debt funds. A fund portfolio should ideally comprise 5-7 funds. Your asset allocation between debt and equity should be in line with your risk appetite. Any mismatch or imbalance will lead to exposure to higher risk or inability to achieve the corpus within the desired time frame.

Selecting the right schemes: It is important to select the right schemes within the preferred category, based on the consistency in generating good returns (measured by rolling return), risk-return trade-off (Sortino ratio) and expense ratio.

Some better performing equity-oriented funds selected based on the above parameters are Aditya Birla Sun Life Frontline Equity (large-cap), Mirae Asset Emerging Bluechip (mid-cap), ICICI Pru Value Discovery (multi-cap), Axis Long Term Equity (tax planning), and HDFC Balanced (balanced equity-oriented).

Some of the better performing debt funds include HDFC Liquid, IDFC Ultra Short Term, Aditya Birla SL Treasury Optimizer (Short term income), ICICI Prudential Banking & PSU Debt, UTI Dynamic Bond, and SBI Magnum Gilt Fund - Long Term.

Mode of investment: Investors can consider either lumpsum or Systematic Investment Plan (SIP) to invest in mutual funds. Lumpsum investment is suitable while investing in debt oriented funds. Lumpsum investment in equity oriented mutual funds may not be a wise idea since it is not easy to time the market.

If the market declines significantly after a lumpsum investment, there could be sizeable erosion in the capital invested.

SIP is a more disciplined approach through which investors can invest small sums at regular intervals. It inculcates the habit of saving and building wealth for the long term. SIPs work well irrespective of market conditions and help reduce risk through rupee cost averaging. (SIPs enable purchase of more units when prices are down and vice versa. This is called rupee cost averaging).

Power of compounding

By investing in mutual funds, one can reap the benefits of compounding, that is, the gains made are reinvested, thus compounding the gains. Compounding works well over the long term.

The chart below shows the growth of SIP investments in Sensex across time-frames. It is seen that SIP investment for a longer time-frame achieved better results than for shorter periods.

There are other value added services offered by fund houses, such as Systematic Transfer Plan (STP), Value averaging investment plan (VIP), smart SIP and Power SIP, which help investors phase their MF investments according to their need.

You can start a SIP either online or offline. The online route includes websites and mobile apps of AMCs, MF Utility, CAMS, Karvy, banks, broking and online distributors. You can also fill physical applications at AMC service centres, banks and brokers’ branches.

Preserving the corpus

In the second phase of the investment cycle, the investor has to find a way to enhance returns while preserving the amount invested.

Step up investment: You can step up the investment withrise in the income level. This can be done either through lumpsum investments or by topping up SIPs. This can help accumulate a larger corpus and in reaching the goal before the defined time frame. For instance, a normal SIP in Sensex index with a monthly instalment of ₹10,000 over the last 20 years has generated a corpus of around ₹1.05 crore. But a top-up of ₹1,000 every year in the monthly instalment, has a dramatic effect, increasing the corpus value to ₹1.64 crore (see chart).

Many AMCs provide the option to select automatic top-up facility while filling the application form. A separate form is also available to top up the SIP instalment.

Another important aspect to consider is that one should not stop or sell the SIP investment during market downturns; this will make you miss out on rupee cost averaging.

Review and rebalance: Over time, the defined asset allocation structure tends to change due to the outperformance or underperformance of the underlying assets in the portfolio. It is mandatory for investors to realign and get back to the original asset allocation. This will help keep the portfolio on track and achieve the goal in the desired time frame. Also, there are some circumstances under which you need to rebalance the fund portfolio. The risk level of an investor can change due to increasing age, change in income flow, etc. Asset allocation has to be realigned based on the altered conditions.

At times, some asset classes can generate lower returns due to macro or regulatory changes; this can impact the objective of the portfolio. A case in point is the fall in small saving rates in the recent period. Investors have to carefully realign the portfolio without changing the risk level of the portfolio in such situations.

A new asset class, say, a real-estate fund or a commodity fund may be introduced, which you may want to take advantage of. You may then have to sell a part of your existing investment and re-invest in this new asset class. Change in the tax structure can also call for portfolio re-jig.

There are many value added features that AMCs offer like STP, flex STP and triggers that can help rebalance the fund portfolio.

You also need to keep track of the performance of the funds that you invested in. There are websites such as Value Research Online and Moneycontrol that help measure and compare the performance of funds with their peers and benchmarks. A periodical review of at least once in six months will help keep the portfolio on track.

Redeem to reinvest

The end is always the beginning. This principle is true for MF portfolios too as you cannot take it easy after redeeming your funds. In most instances, the funds have to be redeployed so that they can continue to generate returns, albeit at a lower rate.

When to redeem: Redeem your funds at the chosen time so as to use them to achieve your goals. If you have managed to accumulate the corpus prior to the defined time frame, it is advisable to shift the funds temporarily to lower-risk instruments such as bank fixed deposits and liquid mutual funds. You can then redeem the proceeds whenever required.

There are some anomalous situations where investors may be required to sell some of the funds in the portfolio. This can be caused by persistent underperformance of the fund for 4-6 consecutive quarters, change in taxation and situations like credit default of the debt instrument that the fund holds.

How to redeem: If the goal of the portfolio was children’s marriage, education, etc, the redeemed funds need not be redeployed. However, if the corpus has been accumulated for retirement, you can manage the post-retirement portfolio in multiple ways.

One, if you have already rebalanced the portfolio according to your risk profile at the retirement age, then you need not redeem the entire corpus. You can use Systematic Withdrawal Plan (SWP) to transfer a defined sum of money to your bank account. The fund house will sell the required units in the fund specified by you.

Those who want little risk and certainty in income flows after retirement can sell the entire corpus and shift it to bank fixed deposits or post office monthly income schemes. However, if you wish to continue mutual fund investments post-retirement, but in funds with relatively lower risk, you can re-deploy the corpus in liquid, ultra-short term and arbitrage funds. Retirees with medium to high risk profile can consider allocating some of the funds to equity large-cap funds, balanced equity oriented funds and equity savings funds. You can use Systematic Transfer Plan to shift your investments.

The Dividend option of mutual funds is not recommended for those wanting regular income as dividend payment is not mandatory for mutual funds. Further, the dividend declared in debt oriented funds is not tax efficient as dividend distribution tax of 28.84 per cent is deducted from the sum paid to investors. However, the dividend declared in equity oriented funds is exempt from tax.

Contingency fund

As a rule of thumb, you should keep at least six months of your salary as emergency funds. Liquid funds are relatively low-risk, low-return products which are suitable for parking your contingency funds as the redemption proceeds are normally credited in the investors’ bank account in 24 hours.

Many AMCs now allow instant redemption facility from liquid funds up to ₹50,000 to individual investors, enabling them to get money in their bank accounts within minutes.

The real value of your goal

It is important to calculate the amount needed for investment to achieve the desired corpus, based on the desired rate of return.

For instance, if you choose the systematic investment plan (SIP) route to achieve ₹1 crore for retirement corpus with 12 per cent expected annual rate of return in 20 years, then you have to invest around ₹10,000 per month. Given that inflation eats into the return, we have to increase the monthly instalment amount based on inflation expectation. In the above mentioned example, if we assume long-term inflation of 6 per cent, the inflation-adjusted corpus after 20 years would be around ₹3.2 crore. To achieve that, you need to invest a higher amount of around ₹32,000 per month.

Ready reckoner

SIP: Systematic Investment Plan allows investment of a fixed amount every month or quarter

STP: Systematic Transfer Plan allows transfer of a pre-determined amount from one mutual fund to another mutual fund (of the same AMC) periodically

SWP: Systematic Withdrawal Plan permits receipt of a pre-determined amount from a fund into your bank account

Flex STP: Allows transfer of variable amounts linked to value of investments

Smart STeP: Offered by Reliance MF, allows transfer of variable amounts into another scheme depending on the market conditions

Trigger: It is an event on the occurrence of which the fund will automatically redeem/switch the units

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