Mutual Fund Portfolio- How to Build a Mutual Fund Portfolio

It is quite clear that mutual funds are a fantastic way of building a long term portfolio to meet your financial goals. The question is about the process. How to actually go about the process of creating a mutual fund portfolio?

Clearly, there are no golden rules to create a mutual fund portfolio. However, it should be predicated on two basic principles. The first principle is the principle of investing in sync with your goals. You cannot invest in mutual funds in isolation. The second guiding principle is about discipline. The mutual fund portfolios is about time in the market, not timing.

Step 1: Start With your Goals and Tag Each Mutual Fund to Specific Goals

This is where it all starts. If you want mutual funds to work in your favour, then start off with your goals in mind. You need to set clear life goals and put a financial value to it because if you don’t know where you want to reach, it will not matter how fast you run. How much do you need as a retirement corpus and how much you need for your child’s education? How much you need to save for your home loan margin and how much do you need for an exotic holiday?

These questions will determine your asset allocation. For example, you tag equity funds to long term goals and debt funds to short and medium term goals. All your goals have to be defined in terms of target amounts and time frames. Now comes the most important part of tagging specific funds to your goals, What does that mean? Every mutual fund holding must be tagged to a specific goal. You can say that Fund A,B and C are for retirement. Alternatively, Funds E,F and G are for your daughter’s college fund etc. Tagging gives purpose to your mutual fund investments so you can clearly monitor the progress of your investments towards these specific goals.

Step 2: SIP Route is the Best Way to Create Mutual Fund Portfolio

Here, in this step, we resolve the dilemma between lump sum investing and systematic investment plan. Which should you adopt. SIP approach to investing has a lot of distinct advantages to it. Firstly, it is less about investing and more about discipline, which is the core of creating a long term mutual fund portfolio. Once the discipline of SIP is inculcated, then wealth creation becomes a passive process.

SIPs match your investment allocations to your cash flows. Since inflows are normally monthly, a monthly SIP ensures that you don’t have the problem of cash flow mismatch. Lastly, SIPs being phased investments offer the benefit of rupee cost averaging. You basically get more value when the markets move up and a greater number of units when the markets are down. It is like a case of heads you win and tails you don’t lose.

Step 3: You Need to do Your Homework Before Investing in Mutual Funds

When you are working towards investing for your goals. You delegate the task of wealth creation to the mutual fund but what you cannot delegate is the job of still being the leader. You must do proper homework before investing in the funds. The funds you buy must be in tune with your goals. For example, cannot buy a high risk fund for a low risk goal and the reverse is also true. You have an array of equity funds, debt funds to choose from. You can select between dividend and growth plans. You can also select between regular options and direct options. There is a wide choice available to you.

In mutual fund portfolio creation, you must focus on consistency of past returns more than CAGR, which is normally misleading. Always prefer the growth option over dividend option since it is an auto wealth compounder. They are also more tax smart. With regards to direct versus regular options, you must take a call based on whether you can make a prudent choice on your own or you need professional help. Essentially, direct options come with no advice, albeit the costs are much lower.

Step 4: Split Mutual Funds into Core and Satellite Holdings

What do you understand by splitting the portfolio into core and satellite portfolios? The core portfolio is the one which is tagged to your long term and medium term goals. These are the funds that will get you to your long term and medium term life goals. Normally, you don’t disturb these unless there is a strong case to rebalance as per your annual review.

The satellite portfolio is opportunistic in nature and aims for alpha. Here, and satellite must be a small component only, you can look at sector funds, index funds, gold funds, thematic funds as specific opportunities. On the debt side, you can shift based on interest rate outlook and also look at higher risk credit opportunity funds. The rule is that you should try for alpha only in your satellite holdings not on your core holdings.

Step 5: Monitor Fund Holdings on Returns and Risk Vis-à-vis Goals

Your job does not end with creating a portfolio of mutual funds; it also has to be reviewed regularly. For example, if the equity markets are getting overheated or if sectors are getting overheated, then you need to scale down exposure. Similarly, you must add exposures when valuations are salivating. But more importantly, you must always measure if your core portfolios is in sync with your goals the annual review helps you to take decisions like whether you need to take more risk or you need to increase your monthly outlays.

The core portfolio must be monitored to check if funds are consistently underperforming the index or the peer group. Draw red herrings if the fund manager is taking on too much of risk or if there is too much of churn in the fund management teams. Also judge your portfolio based on time based milestones. If you have a goal maturing after 15 years, then 6 years is long enough time to judge whether you are on track with your mutual fund portfolio or not.

The moral of the story is that your mutual fund portfolio is the key to your long term goals and life dreams. You must put in a lot of effort and your best foot forward. A little bit of extra effort from you side will go a long way in making your mutual fund portfolio more effective and more meaningful for your goals.