Whether you want to invest via SIP or a lumpsum amount, mutual funds provide a variety of perks from diversification to long term compounding benefits.
Your final choice of funds has to be preceded by several points like investment horizon, risk appetite, etc.
The longer you stay invested, the higher your chances of substantial returns but you may require the amount earlier or you may have short term goals.
Therefore you will need to prioritize the time horizon before selecting the funds.
The Importance of time horizon
We live in a world of instants, from instant coffee to instant messaging.
Mutual funds do not fit into this world, they are like a slow cooked meal.
Staying invested for a long time duration not only increases your chances of substantial returns but also lowers risk.
Risk here alludes to depreciation of capital, the longer you stay invested the lower the chances of the prior.
Every mutual fund scheme category carries varying level of risk, therefore investing in a fund meant for a long term period for a short term period can be extremely fatal to your hard earned money.
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Fund recommendations based on Duration
The investment horizon of an investor is dependent on the financial goals as well as the risk appetite of the investor.
If the goal is retirement planning then there is no sense in investing in funds ideal for short term needs.
If your time horizon is zero to two years then you can consider liquid or short and ultra short duration funds.
These funds are apt for capital protection since that is the primary objective.
Of course, you have to keep your returns expectations realistic since such funds cannot compete with equity funds.
Their returns are either at par or more than fixed deposit for the same time period but the returns are not guaranteed.
Such funds can be considered for short term goals like a vacation or a fixed expense you are sure you need to attend to.
Two to five years
In such a scenario you can consider hybrid funds which have a certain portion invested in equities.
You are still not in a position to invest in a pure equity fund at this stage.
Such funds can be considered for short term goals like purchasing a car, making a down payment for a house, etc.
Since hybrid funds have exposure to equity their risk levels are higher than debt funds but so is their potential with regards to returns.
Hybrid funds can be divided in the following manner
- Aggressive hybrid fund
- Conservative hybrid fund
- Multi asset allocation
- Equity savings fund
- Dynamic asset allocation fund
- Arbitrage fund
An aggressive hybrid mutual fund needs to invest a minimum of 65% into equity at all times which can go up to 80% maximum if so desired.
The debt portion should be at a minimum of 20% at all times.
A conservative hybrid fund by regulation requires 75 – 90% of its total assets invested in debt or fixed income securities.
The remaining 10 – 25% has to be allocated to equities.
A Multi Asset fund means a mutual fund that invests in three or more asset classes.
Equity savings fund are an open-ended hybrid fund investing in equity, arbitrage and debt.
They need a minimum of 10% to be invested in debt funds securities.
A dynamic asset allocation fund is more popularly known as a balanced advantage fund.
It invests in debt, equity and arbitrage positions although the allocation is not fixed.
It can also sit on cash if the fund manager desires so.
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Five to Seven years
Now this is when you can consider pure equity funds.
These include large, multi and flexi among others.
Such funds are ideal for mid to long term investing, the longer you stay invested the better.
However one still should avoid thematic, sectoral and small and mid cap funds since they require a longer time horizon to average out the volatility.
The longer you stay invested, lower the chances of losses but returns are still not guaranteed.
For such a time horizon you can consider mid and small cap funds.
They have the potential to generate more returns than flexi and multi cap funds but they can also be highly volatile in the short term.
In the long run, the volatility averages out.
Such funds should ideally be a part of your portfolio and not the complete portfolio itself.
Such funds are ideal for long term wealth creation, however any disruption via periodic redemptions can cause a dent.
These funds can also be extremely volatile in the short term so one needs to have immense patience and will to be able to weather the storm in the short term for long term gains.
Before looking at past returns while selecting a fund, divert your attention towards your risk appetite.
Keep the basics in place and complexity at bay, for short term capital protection takes precedence over capital gains and for long term investing you need to stay invested to let compounding weave its magic.
As the old cliché goes, time spent in the market is more important than attempting to time the market.
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