Will you be able to diversify into different asset classes through just one avenue? Yes… definitely.
Mutual funds are the one avenue that allows you to invest in different asset classes such as Equity, Debt, Gold, Cash, etc.
Now, once you decide to construct a portfolio that provides you diversification and growth, the question comes in how to construct a Mutual Fund Portfolio?
Following are the 6 very important points to keep in mind while constructing a Mutual Fund Portfolio.
1. Identify your Risk tolerance level
This is the very first step before starting any investment. Generally, all investors can be categorized under 5 types of Risk profiles.
- Low-Risk Takers
- Moderately Low-Risk Takers
- Moderate Risk Takers
- Moderately High-Risk Takers
- High-Risk Takers
Your Risk profile depends on your age, family background, Net Worth, Goals, Time frame, and even on some psychological factors.
If you are a low-risk taker, then higher exposure towards Equity is not recommended. But, for example, if you are a high-risk taker i.e. you want to take a higher risk for generating higher returns, then Equity is for you.
Find out your risk profile. (Link for Risk profile questionnaire is to be given if we can)
2. Keep in mind your Financials Goals and objectives
While constructing a portfolio, you need to take into account your goals and objectives. In other words, when exactly you will need your money back.
For example, if your goal is 10 years away, then definitely Equity is the best asset class. On the other hand, if you need money after 1-2 years, then a debt asset class is preferable. This is because the Equity Asset class tends to be more volatile in the short term. But, it can beat inflation in the long term.
Hence, the Time Frame of your goals will play an important role in constructing a portfolio.
3. The right mix of Equity, Debt, Cash & Gold (Asset Classes)
After you know your Risk Profile and the time frame of your goals, you can choose your right mix of asset classes. If you have a long-term view say 8-10 years and you are ready to take a risk, then more exposure towards Equity Asset class is preferable.
If you have a Medium-term view say 3-5 years and you are not ready to take a risk, then more exposure towards the Debt Asset class is preferable.
If you have a Short term view, say 1-3 years, then you should not take risks. In this case, exposure towards Equity can be minimum and Debt asset class should be preferred.
Gold is an important part of an investment portfolio if you want diversification in the portfolio. Though the price of gold can be volatile in the short term, it has always maintained its value if you consider it for the long term. It is a hedge against inflation. 5-10% exposure in Gold is recommended.
4. Diversification of AMC and the right number of schemes in a portfolio & Asset Classes
Diversification in AMC/s is also recommended. Sometimes, people end up choosing all the schemes from one AMC (Asset Management Company). It is important to choose different AMC /Fund Houses for investment as each fund house has its style of fund management and investment philosophy. Further, it may happen that a fund manager of a fund house is managing multiple schemes.
Diversification is important. But, over-diversification will not reduce your risk and it will make your investment management a difficult and tedious process. Hence, a maximum of 7-8 Mutual Fund schemes of different categories is recommended.
5. Map your Goals to Specific investments or a portfolio
Once you create a portfolio or make any investment, you must map it to a specific goal or objective. This will reduce a change of unnecessary or early withdrawals. It will create a sense of discipline in investment.
6. Review your portfolio regularly
Last but not the least, you should review your investments periodically to know whether you are on the right track. Review of investment is important to make necessary changes if required. Don’t forget to rebalance your portfolio if needed. In case, your Equity portfolio is on a higher side due to profit, shift the required amount into debt and vice versa. In this way, you can maintain your pre-decide asset allocation.
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