Firstly, it’s scary to look at the universe of all available mutual funds and then select the best funds for your goals. There are about 44 mutual fund houses offering more than 2500 schemes for us to invest our money. Is there a “sensible default” way to invest your money in equity mutual funds?
Before discussing what is the “sensible default”, we will look at what are the risks of choosing wrong mutual funds.
- Deviates from the mentioned scheme objective
- Takes too much risk than mentioned initially
- No real returns for the risks being taken
- Exit loads to exit and investment if they do not perform well
Fear not, there is a an easy sensible default methodology of investment in equity mutual funds. It gets even better – the whole process is extremely simple and easy to understand.
Before we proceed, it is important to understand some basic types of equity mutual funds and the associated risks.
- Large cap – High market capitalisation (lowest risk, big blue chip companies)
- Mid cap Funds – Mid market capitalisation (Higher risk, mid-sized companies)
- Small cap – Lowest market capitalisation (Highest risk, small growing companies)
- Flexi cap – Funds which invest in combination of Large, Mid and Small capitalisation companies (mixed risk, depends on fund)
- Index funds – An index fund is a portfolio of stocks or bonds designed to mimic the composition and performance of a financial market index. (From Investopedia.com)
- Thematic funds – Funds which are based on themes (Banking/ energy/ Infrastructure theme etc)
- ELSS – Equity linked savings scheme (which have 3 years of lock-in period before withdrawal and provide tax benefits under section 80C)
For that, we need to decide the time frame of the goals for which we are investing in mutual funds. Anything less than 5 years is not ideal to invest in equity mutual funds. I generally classify my goals into the below time frames:
- < 5 years
- > 5 years and <= 7 years
- > 7 years and <= 10 years
- > 10 years
So I matched my risk taking ability with the goals and came up with this “sensible default” way of investing:
- < 5 years – No mutual funds
- > 5 years and <= 7 years – Large portion of your investments in Large cap Index funds
- > 7 years and <= 10 years – Large portion of your investments in Mid cap Index funds + Large cap Index funds
- > 10 years – Large portion of your investments in Small cap Index funds + Large cap Index funds
Finally, as you go closer to your goals, you move your fund from Small cap Index to Mid cap Index and then to Large cap Index, then finally to safer no risks instruments.
So create your “sensible default” fund, just search Large Cap Index fund in India in google and you will find a fund that matches your requirement. Good luck 🙂
