Goal-based investing through mutual funds

Here’s a guide that will help you in Goal-based investing through mutual funds:

Goal-based investing through mutual fundsEach one of us may have a financial goal to achieve. It may be a short-term or a long-term goal. It can be related to self-improvement or empowerment of the family member. The goals usually pursued relate to near term like purchasing a car, or improving the home décor, going on a vacation. It may lie sometime far in the future like getting a regular income post retirement. You may think of saving to give a better future to your children.

Aspiration alone doesn’t help. You need to plan for it from today onwards. Along with that, prioritisation of goals is necessary. Place your goals in a hierarchy starting from most important to least urgent. It gives you a realistic picture of where you are and where you want to be. Then, think of the ways and means to finance the goal. A source that is reliable and versatile enough. It should give you broad-based diversification at a reasonable cost and minimum indulgence.

Whatever be the financial goal, Mutual Funds are a great option to realise them. They have got all the right things to make your dreams come true. Mutual Funds are professionally managed investment vehicles that counter inflation, provide diversification, risk-adjusted returns, tax efficacy, cost-effective investment and goal achievement. Each mutual fund scheme would have an investment strategy. According to that, it allocates money pooled from investors to the underlying scheme assets.

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You may think of investing directly into markets. However, trust me, you cannot get that level of diversification at that less cost. Moreover, you can relax. Let the fund manager track and rebalance the portfolio to give you required returns.

Financial goals may be short term, medium term or long term. Short-term goals have short investment horizon of up to three years. Medium term goals may have a horizon of 4-7 years. Long-term goals usually have investment duration of up to 10 years and more.
Your goals determine the risk tolerance. It means the extent to which you are ready to lose the principal/interest earned.

So, read on to understand how mutual funds allow goal achievement.

Goal-based investing through mutual funds

Short-term Goals

In short-term, parking your funds in riskier assets won’t be prudent. It may be to find a haven to park surplus funds for a short while. Alternatively, it may relate to goals like creating a corpus for pursuing higher education, getting married, going to exotic vacation or buying a car. You require stable returns and protection of your capital. The risk appetite is very constrained in such a short duration. Additionally, you may prefer a fund which allows quick redemption. In other words, you need a fund with cost-effectiveness & high liquidity.

Liquid funds & Ultra short-term funds are ideal for investment horizons of up to 1 year. Both of them invest in fixed-interest bearing short-term instruments i.e. treasury bills, commercial paper, certificate of deposit, etc. The pre-tax returns are in the range of 7-9% which is far better than the meagre 4% interest earned in saving bank account. Ultra short-term funds have been found to give slightly higher returns than liquid funds. It is because these may invest in low-rated securities as compared to only high-rated investments in case of liquid funds.

The redemption is easier for liquid funds as these do not levy exit loads after the distinct periods. Therefore, apart from goal-based investing, you may also park the amount that you set aside for contingency. You may also use them towards monthly income by way of systematic withdrawals.

Suppose you have goals which have a tenure ranging from 1 year up to 3 years, then try income funds or fixed maturity plans.

Fixed maturity plans (FMPs) are close-ended schemes that invest in debt instruments having maturity from 30 days to 5 years. The fund manager matches the tenure of securities with that of the average maturity of the scheme. It, thus, provides steady income by protecting the portfolio from interest rate risks & by avoiding the premature sale of securities. The only risk lies herein is the lack of liquidity. Unlike FDs, you cannot redeem your investments before maturity.

If liquidity is your prime concern, then try Income Funds. These carry similar benefits of FMPs but with much liquidity. The fund manager generates return either by holding securities until maturity or selling them when their prices are high. These are better than FDs from various angles. These offer higher returns than FMPs, don’t carry reinvestment risks & are tax efficient. When you hold your investments for 3 years and more, you get indexation benefit of 20% on capital gains.

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Medium-term goals

When you have medium-term goals, your investment horizon would be 4-7 years. In this phase, you may venture out to take moderate risks. Accordingly, you would be concerned about higher returns as well as tax efficacy. It is the time when you may think of getting some exposure to equity.

You may go for Balanced Funds. Balanced Funds presents a blend of equity & debt to give you moderately-higher returns while keeping portfolio risk profile stable. In the case of equity-oriented balanced funds, the fund manager makes equity investments to the tune of more than 65% and rest in debt. These deliver higher returns than pure debt funds but at a relatively higher standard deviation. When you stay for more than 1 year, the long-term capital gains become completely tax-free.

For the risk-averse, Monthly Income Plans do better. These invest primarily say 60-70% in debt securities and money market instruments while a small portion in equities. The main aim to invest in this would be to enjoy steady income from investments. Those who are looking for capital appreciation may also invest here. The quantum of income may fluctuate owing to volatile markets. However, historically they have rendered dividends regularly. The short-term capital gains are taxed as per your tax bracket. Like other debt funds, the long-term capital gains receive the indexation benefit of 20%.

Also read: How to select a good mutual fund that suits you best

Long-term Goals

Long-term relates to a period of more than 7 years. During such time, individuals pursue goals like retirement planning, saving for child’s education or marriage, buying a house, etc. You, as an investor, would prefer high returns from your investments. Usually, preservation of capital takes a back seat, and you can afford to take greater risks. When the matter of high risk-high return comes forth, you cannot ignore equities.

To achieve long-term goals, equity mutual funds have been the most preferred lot. Within equity funds, there are variations like diversified equity/ELSS, large/mid/small cap and sectoral funds. You may choose among these according to your risk profile.

Large/mid/small cap equity mutual funds invest according to the market capitalization of companies. Market capitalization is the product of market price and the number of shares floating in the market. Large cap companies have a market capitalization of Rs 200 billion to Rs 3500 billion. These are the established ones which deliver consistent performance in both bullish 7 bearish phases. Mid-cap companies have a market capitalization of Rs 50 billion to Rs 200 billion. These are much more volatile but generate higher returns than former. Small caps are the riskiest ones with huge upside & downside potential.

Sectoral funds invest in particular sectors like IT, power, infrastructure, banking, technology, pharma, FMCG, etc. Too much concentration in a particular industry makes them riskier compared to diversified equity funds. The performance of the fund is highly correlated to sector performance. It is a high risk-high return punt which mostly suits the aggressive investor. The fund manager needs to possess remarkable foresight regarding prospects of the industry. Alternatively, else, the investor would be declined to doom.

Diversified Equity Funds invest in stocks of companies regardless of the sector, industry or market capitalization. The broad diversification spreads the investment risk across companies to avoid losses owing to particular risks. Their objective is to ride the stock market & take advantage of the financial growth of companies. These endeavour to deliver high returns to investors via strategic stock-picking. ELSS is one of the categories of diversified equity mutual funds. These provide twin benefits of superior returns & tax saving. Investments in ELSS up to Rs 1.5 lakh are exempt from tax under Sec 80C of Income Tax Act. Moreover, the dividends & long-term capital gains are tax-free. The only catch here is the lock-in period of 3 years. However, when compared to other tax-saving instruments, this is the minimum lock-in period.

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Final Words

Your goals, risk appetite & investment horizon, should guide your mutual fund’s selection. Each fund invests as per the investment mandate as mentioned in the offer document. You need to understand the terms & conditions absolutely before investing. Choose a fund that matches your needs and investment philosophy. Do remember to diversify your investments to avoid the risk of losing money.

Mutual Fund investments are subject to market risks. Please consult your financial advisor before investing.

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  • dev chand says:

    Good article.
    How many MF schemes should be there? Ideally for diversification, 4-5 are preferred. Then, how to strike a balance between goal based and minimal portfolio.

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