How to Build a Mutual Fund Portfolio? Here’s a 7-Point Guide to Creating an Ideal Mutual Fund Portfolio for Long Term
Mutual funds are an excellent investment option for creating long-term wealth. They will help you meet all your goals, making you financially secure. However, you cannot invest in just one mutual fund to realise your goals. Different goals require different funds, and all these funds put together form a mutual fund portfolio. Although there is no specific rule of thumb to create a mutual fund portfolio for the long term, you can follow a few steps to create one.
What is a Mutual Fund Portfolio?
A mutual fund portfolio is a collection of mutual fund schemes that fit your goals, investment horizon and risk tolerance levels. You can choose to manage your portfolio or take help from a financial advisor who can help manage the portfolio for you.
Although there is no ideal mutual fund portfolio that suits everybody, all portfolios must have one thing in common, which is diversification. In other words, it means you must spread your investments across mutual fund schemes across categories to spread the risk of investing. Now that the most important rule of investing is clear let's see how to create an ideal mutual fund portfolio that suits you.
Strategy to Create a Mutual Fund Portfolio for Long Term
There are no golden rules to creating a portfolio, but the following steps will guide you through creating an ideal mutual fund portfolio for the long term that will suit you the best.
#1 Identify your goals and resources
The first step towards investing is to evaluate your resources and identify your goals. Prepare a financial plan with your income and expenses. See where you can save by cutting down on unnecessary expenses. Only if you can save can you invest.
Next, you have to identify your goals. What is the reason for investing, and what goals do you want to achieve by investing? How much will you need to fund your goals? By when do you want to achieve these goals? Ask yourself these three questions and write down the answers on a piece of paper.
Once you answer these questions, you will have your goals, target amount, and investment horizon. Investing without a goal is travelling without a destination. You don't know where you are going. Although that's exciting for some time, in the long term, it can be exhausting. Also, only if you know your target amount and investment horizon will you know how much to start saving today and until when. Hence being aware of one’s goals is very important for any investor to invest in any asset.
#2 Understand your risk-taking ability
Once you've identified your goals, assessing your risk-taking ability is important. Sometimes you think you can stomach the high risk but end up panicking during unfavourable market situations. Hence it is important to understand your risk tolerance level. Factors such as your age, responsibilities, and how you perceive a market correction help determine your risk profile.
You can take a risk profiling questionnaire to understand what is your risk-taking capacity. Download a risk profiling questionnaire from the internet for free to understand your risk-taking ability.
But why is risk profiling important? You can identify asset classes for your portfolio based on your risk profile. Each asset class has varying levels of risk. For example, equity has the highest risk, and fixed deposits have the least risk. So, depending on your risk-taking ability, you can choose the best investments for your portfolio.
#3 Determine asset allocation
Determining your mutual fund portfolio allocation should be done before you decide where to invest. It is based on the asset allocation that you will determine where and how much you will put your money. There are several types of mutual funds such as equity, debt, and hybrid funds. Within equity, there are several categories, such as large-cap, mid-cap, small-cap, value funds, etc.
Each of them falls under different risk levels and gives different returns. Hence it is important to determine your asset allocation before you decide on your investments.
You can use different asset allocation strategies, such as the 100 minus age rule or the 80-20 rule. In the 100 minus age rule, you will invest in the percentage of your assets similar to your age in debt and the rest in equity. This is because it is assumed that one can assume more risk at a younger age than when they are old. So, if you are 25 years old, you can invest 25% of your assets in debt and 75% in equity. In the 80-20 rule, you can invest 80% of your assets in equity and 20% in all the other asset classes, such as debt and gold.
Each of these strategies has limitations, and it is best to determine your asset allocation strategy based on your goals. For example, for a long-term goal like retirement, you can invest all your assets in equity. For a short-term goal like buying a car, you can invest most of the assets in debt.
#4 Select funds to invest
After determining your mutual fund portfolio allocation, you must pick the funds for your mutual fund portfolio. When selecting funds, ensure your portfolio has a maximum of six to seven funds, as anything more than that can make your portfolio unmanageable.
The fund selection must be made meticulously using both quantitative and qualitative parameters. You must check the past performance of the fund to understand the consistency in giving good returns. Then, compare it with the benchmark and peers to see by how much it has outperformed both.
Apart from performance, you must check its expense ratio, portfolio turnover ratio and risk-adjusted returns such as Sharpe and Sortino ratio. The fund manager’s expertise and experience also play an important role in the performance of the fund.
Use quantitative and qualitative factors to analyse the fund before selecting it as a potential candidate for your portfolio.
#5 Choose your strategy
You can invest in mutual funds in two ways, through SIP (systematic investment plan) or lumpsum. SIP is a facility that allows you to invest a small amount regularly for a period of time. It is best for the salaried class, who receive income monthly. Since you will invest over a period of time, you can benefit from rupee cost averaging, which will reduce your average cost per unit. You can enable auto-debit to ensure you aren’t missing out on your SIP instalment. Additionally, you can step up your SIP amount every year to beat inflation.
In lumpsum investment, you will invest a certain amount once in a mutual fund and stay invested until the end of your investment horizon. Lumpsum investment is best when you have a huge sum of money. For example, salaried class bonuses and yearly incentives can be invested through the lump sum route.
After selecting your funds and deciding your strategy, you must invest to realise your goals. You can invest through offline or online modes. For offline, you can visit the mutual fund office, submit the application form and give a cheque to start your investment journey. However, offline investing is considered time taking in the current era of digitisation. Hence you can consider investing online.
You can directly visit the asset management company's website to invest, or you can go to any online platform offering mutual funds, such as Jupiter Money. Online investing is just like online shopping. You have to select the funds you want to invest in, do your digital KYC and submit your bank details, and within no time, you can become a mutual fund investor.
By investing through online platforms, you can also see all your investments in one place, helping you to track your progress towards your goals.
#7 Don’t stop with investing
You cannot invest and forget. It is important to monitor your investments regularly to track their progress. Since mutual funds are marketable securities, you must monitor them. Today's best-performing fund might not perform well after a few years affecting your portfolio returns. Hence you must do a yearly review of your portfolio.
One easy way to monitor your funds is to track the progress towards your goal. If your portfolio isn’t making enough profits for you to reach your goal, then it's time you rebalance it. Portfolio review and monitoring is a tedious process. You must check the fund's performance, compare it with peers, and benchmark. You must also check the risk-adjusted returns, expense ratio, and whether the fund manager is investing based on the objective or not.
Since all this takes time, you can use an online tool such as Jupiter Money’s portfolio analyser tool to check the health of your investments. The tool will tell how your portfolio is performing with respect to the market and also suggest some funds to rebalance it, if necessary.
Remember, portfolio monitoring is as important as investing, and you should never neglect it.
Things to Keep in Mind When Building Your Mutual Fund Portfolio
Now that you know how to build a portfolio, here are a few things you must keep in mind before starting your investing journey.
Have an emergency fund: Before investing for your future, you must set aside money for uncertainties or emergencies. Since you never know when an emergency can knock on your door, it’s better to be prepared. Have an emergency fund with a minimum of 6 months of expenses. Save it in a bank or a liquid fund so you can easily withdraw it when necessary. In an emergency, you can use this fund, and you don't have to put your financial goals on hold.
Understand the market: Have a basic understanding of the market. Check what investment options are available to you. Within mutual funds, you have a host of options available for different investment goals. Understand how these funds can react when the market goes up or down. You don’t have to dig deep and become a financial expert; a basic understanding is enough.
Do proper research and analysis: Check which mutual funds suit you best before investing. Select a fund after checking quantitative and qualitative factors.
Don’t hesitate to get help: If you lack the knowledge and time to do research and select a fund that will help you reach your financial goals, take the help of an expert. Financial advisors will help you invest in the best funds that will best suit your goals and resources. They will also monitor your investments regularly so that you can have a good night's sleep.
Be disciplined and consistent: The secret behind accumulating wealth is to be consistent with investing. Although SIP helps you inculcate financial discipline, you must do your bit by saving that extra rupee. Cut down on costs wherever possible and invest before you spend. This lets you stay consistent with your investments and reach your financial goals.
Frequently Asked Questions
What is a good mutual fund portfolio?
A good mutual fund is one that aligns well with your goals, resources, and risk tolerance levels. Selecting mutual funds based on your goals and risk-taking capacity will help you achieve your goals faster and manage your portfolio better.
How many mutual funds are good in a portfolio?
A portfolio should have a maximum of 6-7 funds. Anything more than that will make it difficult to manage and also lead to over-diversification, ultimately harming your portfolio returns.
What is the minimum time to hold a mutual fund?
There is no minimum holding period for mutual funds; you must invest depending on your investment goals and horizon. It is best to stick to your investment until you want to reach your goals.
For long-term goals (more than five years), equity mutual funds are the best as they have the potential to give good returns in the long term. Invest in debt mutual funds for short-term goals (one week to three years).
Which type of mutual fund is best for the long term?
Equity mutual funds are the best for long-term investments. This is because they are exposed to market volatility in the short term, which can result in losses. However, the volatility smoothens out in the long term, and equity funds can give high returns.
What is an ideal mutual fund portfolio?
An ideal mutual fund portfolio is one that suits your goals and risk-taking capacity. It must also have a maximum of 6-7 funds to ensure adequate diversification.
What is 12-20-80 asset allocation?
The Quantum mutual fund gave a 12-20-80 asset allocation rule. According to the strategy, you must allocate 12 months of your expenses to liquid funds, 20% of the investable amount in gold funds and 80% to equity.
How much should I allocate to a mutual fund portfolio?
Ideally, you must save and invest 20% of your income. Your portfolio allocation will depend on your goals and risk appetite. Equity is the best for long-term goals and high-risk takers. For short-term goals, debt is the best. Investing 20% in equity and the rest in other assets would be ideal for risk-averse investors. Hence, depending on your needs, you must select your asset allocation.
In this article