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Your investments can customarily be summarized in two words - risk and reward. The thumb rule is greater the prospective reward, greater is the risk. However, the rule is not true in reverse order—higher risk does not necessarily mean higher potential reward, unless you know the tricks to mitigate the risk. Here are some strategies that can help you manage your mutual fund investment risk.

Align portfolio with risk appetite

As investment in mutual funds comprise varying degrees of risk, you must factor in your financial position, age and expected income growth in near future to assess your risk appetite. Tailor your investment portfolio based on your risk tolerance level. For instance, investors with moderate to high risk appetite would invest largely in equities to achieve their long-term goals. On the contrary, low risk appetite investors prefer balanced portfolio, which would involve a mix of both debt and equity, even for their long-term financial goals.

Know when to invest in NFOs

New Fund Offers (NFOs) are the first-time subscription offer for any new mutual fund offered by AMCs to the public. They are available at face value of Rs 10 per unit during the offer period. However, many distributors wrongly upsell NFOs by citing their lower NAVs. Given that NFOs do not have past track record for comparing them with peer funds and benchmark indices, you must factor in past track record of other schemes managed by the fund manager and fund house. Opt for a particular NFO only if it comes with unique offerings that suit your risk appetite and financial goals. In case of sector/thematic NFOs, higher risk appetite investors with the ability to track the concerned sector/theme and time their investments should go for them. Otherwise, you are better off investing in existing mutual fund schemes having a good past track record.

Invest through SIP

In a systematic investment plan (SIP) a pre-determined amount is invested in selected schemes at regular frequencies regardless of the current NAV or market level. SIP includes the concept of rupee cost averaging, which averages out the cost at which investors purchase units over time with zero need to time investments and monitor the market. More units are bought when market prices are low and lesser units are bought when the prices are high.

Invest lumpsum surplus via STP

The process to automatically transfer from one mutual fund to another happens via systematic transfer plan (STP) at periodical intervals. Like SIP, STP assists to spread out the investments over the time-period to average the buying cost and rule out risk of getting into over-valued markets. STP can also be used to reduce the market risk as you reach the maturity of your long-term financial goals. Shifting from equities to low risk ultra-short duration debt funds will allow you to consolidate your gains while reducing the downside risk.

Consider asset allocation strategy

Asset allocation refers to the process of diversifying your investments across various asset classes like debt, equities, cash equivalents etc. The objective is to balance your portfolio’s rewards and risk according to your risk appetite and time horizon of financial goals. As equity mutual funds can be highly volatile in short term, investors should consider investing in short term debt funds for financial goals maturing in 36 months due to their capital protection and higher income certainty features.

Build a diversified portfolio

Often, investors put their whole investible surplus in only one scheme, sector/ theme that delivered them good returns in near past. However, doing this concentrates the market risk in only one sector/ theme or fund management team. Unfortunately, if your chosen sector/ theme undergoes adverse market condition or fund management of your selected scheme takes incorrect investment call, your investments may underperform broader market for a long time-period. Instead of placing all your hopes on one investment theme or fund type, diversify your investments across different funds to lower the concentration risk. If any one fund under performs, the other funds in your portfolio will make up for the loss.

Understanding the merits of investing in mutual funds is one side of the story. What is more important is to ensure that you find the right fund. Be it equity, debt or balanced funds, you need to have a clear cut process to identify the funds. Here are six steps to identifying the right fund:

Sync with your goals

Evaluate each fund from the perspective of your own goals. These can be long term goals, medium term goals or short term goals. Check your risk appetite, your risk capacity and your return requirements. Also focus on your tax status and liquidity needs. In case of long term plan, ensure that liquidity is available easily around the milestones.

All about diversification

The primary job of the fund manager is to diversify your risk exposure. This applies to equity funds as well as debt funds. You need diversification across sectors, themes and capitalization in equity funds. You need diversification across duration and credit quality in debt funds. While diversification is seen as a method to reduce your overall risk, it can also provide you with multiple opportunities that you may have otherwise neglected.

Consistency of performance

This is the cardinal rule when you select a mutual fund. You must prefer the fund that gives you consistency. You can check the consistency of the funds’ performance by evaluating it on quantitative parameters such as historical performance and performance vis-à-vis benchmark/peers and by qualitative parameters such as portfolio quality and quality of fund manager/house.

Your fund manager

The most basic measure is the out performance of the fund over the benchmark index. Also, look at the risk taken. If the fund manager has outperformed the benchmark by taking on too much risk then it means your fund manager is compromising your interests. Also, beware of fund managers who rely too much on the market to outperform.

Expense ratios

Irrespective of whether you are investing in an equity fund or a debt fund, compare the total expense ratio (TER) with peers and select the fund that offers performance with the lowest TER. If two funds have expense ratios of 0.50% and 1.5%, respectively, the latter has a much bigger hurdle to beat before money starts flowing into your pocketbook. Over time, these seemingly small percentages can result in a huge difference in how your wealth grows.

Size and pedigree

Return rankings of mutual funds may show out performance by smaller funds, but you must stick to larger funds that have been around for 15-20 years. Larger funds with bigger AUMs are likely to stay on in the business for the longer term. Always invest in the fund which has already established a good track record. Prefer size and pedigree when other factors are taken care of. This test will form the cornerstone of your mutual fund selection. You can still go wrong, but you have at least created a framework for scientific selection of funds. What matters in the final analysis is not how good or aggressive the fund is. What really matters is how well the fund fits into your goals and how it helps you achieve your goals with minimal risk.

You must have heard the saying: Don't work for money, let it work for you. What it means is that once you have a good amount of money, you no longer need to work towards earning money because your returns on investments will take care of your financial needs.

Imagine you have invested Rs 1 crore in Fixed Deposits giving a 5% post-tax return. Even this meagre return will result in approximately Rs 41,000 monthly income in your hands. The same amount invested in a better asset class can result in a higher monthly income. The whole idea is that the moment you have a saving of Rs 1 crore, you can rest assured of getting a certain amount of money in your hand regularly through investment returns without physically working for it.

Today, many people want to retire young and they may not necessarily want to work till 60 years of age. If you are one of those, then it becomes very important to plan your finances smartly. You need to create a good amount of wealth to meet your financial obligations and achieve financial freedom. The best way is to first set a goal of creating your first Rs 1 crore as fast as possible and then let it grow on its own.

Creating your first crore sounds good and is very much achievable, provided you start early because it will not happen instantly. You need to be patient and give your investments a good amount of time to grow. Apart from that, you need to be disciplined in terms of managing your expenses as well, while keeping in mind ever-rising inflation and the number of years you would need money to fund your expenses post-retirement.

Understand the power of compounding

Achieving the target of Rs 1 crore depends on the amount of money you need to save and the financial products you invest in. The amount of money you need to invest will also change based on the financial products you choose and on your asset allocation. If you invest in products like FDs, Public Provident Fund or a similar fixed return bearing financial product, the return is unlikely to exceed 8% per annum. In order to achieve your target of Rs 1 crore by 2030, you will need to invest Rs 42,000 per month for 12 years.

Investing in real estate via monthly mode is not possible and investing in gold may not make sense due to its uncertain prospects. The best option that you have is equity investment via the mutual fund route. If you start a mutual fund Systematic Investment Plan (SIP) assuming a return of 15% per annum, the amount you need to invest will be Rs 25,000 per month, as against Rs 42,000 in a fixed instrument. If you can increase your annual SIP amount by stepping it up by 10% every year than the amount you need to invest per month comes down to Rs 16,500, from Rs 25,000. If you look at the history of stock market returns, Sensex has in fact given more than 16% returns over the last 39 years since its inception in 1979 till 2019. As explained earlier, the key is always long term investing.

The longer you invest via SIPs, the higher will be the returns you get. A monthly SIP of Rs 10,000 with an assumed return of 15% invested for 10, 20, and 30 years will result in a corpus of Rs 27.86 lakh, Rs 1.51 crore, and Rs 7 crore respectively. If you look at the pattern, you will find that doubling the period of investment increases your returns 5 times. Similarly, tripling the period of investment increases your returns 24 times. There is no magic, just logic, which is the power of compounding.

SIP your way to retirement with the help of the power of compounding

Now that you have seen the power of early investing by using the power of compounding, use that to plan for your retirement as well. The best time to start planning your retirement is right when you start working, which is when you are in your 20s. But when you are in your 20s, retirement seems to be very far away. On the flip side, it is also when you have fewer obligations. By saving even a little you would be able to create great wealth. In your 30s, you have to account for expenses towards family such as monthly household budgets, children's' school fees or EMIs for your home or car loan.

The more you delay your investments, the lesser would be the time you have to leverage the power of compounding. Start saving at least 10% when you are in your 20s to have a comfortable retirement when you are in your 60s. If you wait till you turn 30, then you need to save 15% to 20 % of your total income, which will keep on increasing with further delay.
Please mark all your queries / responses to
Information provided on this newsletter has been independently obtained from sources believed to be reliable. However, such information may include inaccuracies, errors or omissions. and its affiliates, information providers or content providers, shall have no liability to you or third parties for the accuracy, completeness, timeliness or correct sequencing of information available on this newsletter, or for any decision made or action taken by you in reliance upon such information, or for the delay or interruption of such information. , its affiliates, information providers and content providers shall have no liability for investment decisions or other actions taken or made by you based on the information provided on this newsletter.