How to Start a Mutual Fund Portfolio

Over the last decade or so, more and more investors have realised the power of mutual funds as an investment option. In August 2024, the mutual fund industry recorded over 16 crore folios or mutual fund portfolio, which highlights the growing popularity of these investment vehicles among investors. So what’s the reason for this ever-increasing popularity, and how can you get started on building your own portfolio for mutual fund investments? Let’s find out!

What is a Mutual Fund Portfolio?

Before we get into the process of creating one, let’s start with the definition of MF portfolio. A mutual fund portfolio is simply the collection of different types of mutual fund investments you hold. Mutual funds come in many categories based on their underlying assets and investment strategies, such as equity funds, debt funds, hybrid funds, index funds and sectoral funds. Each category has its own purpose and is suitable for investors with varying risk appetites and financial goals. By building a MF portfolio, you can balance risk and return, and take advantage of diversification.

Why You Need a Mutual Fund Portfolio

There are several reasons why you should be building a mutual fund portfolio. Check some of them out:

1. Diversification

Mutual funds are inherently diversified. They pool money from a large number of investors, which allows managers to invest in a wide range of securities across different sectors, industries, and asset classes. Because of this built-in diversification, the risk associated with individual investments is reduced as the fund’s performance doesn’t need to rely on the performance of a single stock or bond. 

For example, when you invest in an equity mutual fund, every rupee of yours gets distributed across a portfolio of 40 to 50 stocks. This way you not only reduce the risk posed by individual investments but also save time and effort researching different stocks and market trends.

2. Professional Fund Managers

The second biggest advantage of mutual fund investing is professional management. Each fund is managed by a reputed and experienced manager who has an entire team of researchers and analysts at their disposal. Managers monitor market trends, analyse each company’s performance, consider macroeconomic factors, and make constant readjustments to the portfolio, so it doesn’t stray from the fund’s objectives.

3. Accessibility and Flexibility

Lump sum and Systematic Investment Plans (SIP) are two ways you can invest in a mutual fund. SIPs in particular offer accessibility and flexibility to investors. By choosing the SIP route, you are committing to making fixed, regular payments to a fund. The amount you choose can be as low as Rs. 500, so mutual funds offer an affordable way to invest through SIPs. These plans are also flexible, meaning you can always alter the amount as your financial situation changes. In case of emergencies, most funds even offer the option to temporarily pause the SIP.

4. Versatile Option

There are various categories of mutual funds that are suitable for different financial goals, risk tolerances, and investment horizons. They can help you achieve short-, mid-, and long-term goals. For example, if you have a low-risk tolerance or need to preserve your capital for the short term, you can invest in liquid funds as they can offer stability and liquidity. Similarly, young professionals looking to build a retirement corpus can invest in higher-risk equity funds to earn higher returns in the long term.

Steps to Start a Mutual Fund Portfolio

Understanding the benefits of mutual funds can make anyone wonder how to start a mutual fund portfolio. Follow these 5 steps to begin:

1. Setting Investment Goals

The question you must first ask yourself is “Why am I investing?” Do you want to save for a family trip next year? Maybe to build a fund for your child’s higher education? Or perhaps you wish to create wealth for a comfortable retirement? Your investment goals will define your investment strategy, so it’s important to be SMART about them.

SMART is a goal-setting technique that helps you be mindful of the different aspects of your goal. S is for Specific, which means your goal must be clearly defined. M is for Measurable, which means you should be able to track the progress towards your goal. A stands for Achievable, meaning the goal should be realistic given your financial circumstances. R is for Relevant, which makes sure that your goal aligns with your broader financial picture. 

And finally, T stands for Time-bound, which means you should set a specific deadline for achieving the goal. Every investment goal will require a unique strategy. For example,

• For short-term goals like saving for a car down payment, you can invest in safer mutual funds such as liquid funds.
• For medium-term goals such as buying your dream home, investing in hybrid funds could be an option. These funds balance exposure to equity and debt and offer moderate returns.
• For long-term goals like saving for retirement, equity funds would work best as the risk associated with them tends to go down as time passes, and they also offer the highest returns.

2. Risk Assessment and Time Horizon

Risk tolerance isn’t just about how much risk you are willing to take but also how much risk your personal and financial circumstances allow you to take. Factors such as age, responsibilities, liabilities, and savings, should also be considered in addition to how comfortable you are taking risks when assessing tolerance. Debt funds such as liquid funds and debt-oriented hybrid mutual funds are suitable for conservative investors. Balanced Funds and hybrid funds are considered appropriate for investors with moderate risk appetite, and equity funds like ELSS or small-cap funds are ideal for aggressive investors. 

Every mutual fund scheme comes with a riskometer, which indicates the risk level associated with that particular fund. Be sure to always check it before making a decision.

Time horizon refers to how long you plan to stay invested. This factor also plays a crucial role when selecting mutual funds. For example, equity funds perform well over the long term, and debt funds are suitable for a short-term investment horizon.

For example, a young salaried individual can take on a higher level of risk compared to an older salaried person because they have a longer investment horizon and more time to recover from market downturns. This offers young individuals the opportunity to invest in highly rewarding equity funds which ultimately allows them to build a significant fortune. On the other hand, older investors may not be afforded the opportunity to take on a higher level of risk, because, after a certain point, the goal is to preserve the capital rather than appreciate it.

3. Choosing the Right Mutual Funds

You must make sure that the mutual fund you’re choosing matches the above three factors – your investment goals, risk tolerance, and investment horizon. However, other than these, there are several aspects you should be mindful of when sifting through the options, such as:

AMC’s AUM

The Assets Under Management of an Asset Management Company gives you a good idea of the fund’s size and popularity. If the AUM is large, that indicates that the company is more established and has earned the trust of the investors.

Fund’s Past Performance

Analyse how well the fund has returned over the last 1, 3, and 5 years to get a picture of how consistent it has been. High returns in one year and low in the next are generally not a good indication as it signals that the fund is highly volatile. A fund that shows steady and reliable performance across different time frames should be preferred as it implies that the manager has done well across different market cycles. Always be mindful of the golden rule – Past performance does not guarantee future returns.

Fund Manager’s Track Record

The success of a fund depends on how well the fund manager can identify, select, and manage investments to achieve the fund’s objectives. A skilled manager with a history of strong performance can make a huge difference in navigating different market cycles and selecting the right securities. Understand the fund manager’s investment style and have a close look at how well the funds they’ve managed performed in the past.

Fees and Charges

A mutual fund charges fees such as expense ratios and exit load that can lower your returns. Remember to compare these fees among mutual funds within the same category to make sure that you are making a well-informed investment decision.

Taxes

Along with fees, taxes can also have an impact on the real returns of your investment. Mutual funds are taxed differently based on factors such as holding period and type of mutual fund. If you want to save taxes, you can invest in ELSS. These are also called tax-saver mutual funds as they allow you to claim a deduction of Rs. 1.5 lakh under Section 80C of the Income Tax Act. Do your research on mutual fund taxation to understand the tax implications of your investment to get a better idea about the real returns of your investment.

Liquidity

Liquidity means the ease with which you can convert your mutual fund units into cash. Most mutual funds offer high liquidity and allow you to redeem your units at the prevailing NAV within a few days. Some funds however aren’t very liquid, such as close-ended funds and ELSS. For example, the Equity Linked Savings Scheme comes with a lock-in period of three years.

Risk-adjusted Ratios

Analysing various risk-adjusted ratios such as the Sharpe Ratio, Treynor Ratio, and Alpha can help you understand how the fund performs in relation to the risk it takes. You can use these metrics to assess whether the returns justify the level of risk involved with the fund.

4. Diversification in Mutual Fund Portfolio

It’s already been established that mutual funds come with built-in diversification, but it is still important to invest in a variety of mutual funds according to your financial goals. Ideally, you should consider asset class diversification by including equity, debt, and hybrid funds, as each asset class behaves differently in varying market conditions. Also, align your mutual fund investments with specific objectives. For example, if you’re investing in a particular mid-cap fund for retirement, tag it accordingly.

5. Monitoring and Reviewing Your Portfolio

By now you have assessed your investment goals, risk tolerance, and investment horizon. You have also thoroughly analysed different mutual funds based on factors like past performance and the fund manager’s history. With this information in hand, you can confidently choose the mutual funds that align best with your financial goals, and build a diversified portfolio. But your job is not done yet. It is vital to monitor how your portfolio is performing on a regular basis, as market conditions and your financial circumstances change constantly. 

You need to make sure that your portfolio remains aligned with your goals and that you are on track to achieve them. A review every six months or year is generally recommended. If you are not satisfied with a particular fund’s performance over 2 or 3 years, you should consider breaking ties. Also, it’s important to rebalance the portfolio as time passes. One asset class can outperform another and suddenly your portfolio can become skewed in one direction. Keep up with the market trends so you can make timely adjustments.

Tools and Resources for Portfolio Analysis

You can make use of online tools such as a mutual fund portfolio analyzer to check the health of your portfolio. These tools inspect your portfolio across various parameters and help you understand the many risks that it may hide. You can also use them to understand the composition of your portfolio, which will give you a clear picture of over or under-exposure to specific asset classes and sectors. An example of such an analyzer is the Value Research Portfolio Analyser.

The insights these tools provide can be extremely valuable, but at the same time may be too complex for some investors to fully understand. If you are ever feeling overwhelmed with complex analytics, you should consult a mutual fund advisor who can give you more personalised advice. These advisors can help you build your portfolio from the ground up while making sure that each component aligns with your investment goals, risk tolerance, and time horizon. They recommend a diversified mix of funds, monitor your portfolio’s performance, and also suggest adjustments as needed.

Common Mistakes to Avoid When Building a Mutual Fund Portfolio

• If a fund has delivered high returns in the past, it doesn’t guarantee it will do so in the future. It’s important to analyse a fund’s past performance but it should be done over a period of time. A consistent fund is more attractive than a fund that delivers very high returns one year and low returns the next.
• Many SIP investors tend to stop their investments whenever there is a market downturn. SIPs offer the benefit of rupee cost averaging, where you buy more units when the prices are low and fewer units when the prices are high. During a downturn, you can buy more units for the same amount you regularly invest and when the market recovers, you will earn a higher profit.
• The choice of funds should depend on your unique personal circumstances. Often investors pick funds based on recommendations from family or friends without fully considering their individual financial goals and risk tolerance.
• Don’t underestimate the power of compounding. If you think that your income isn’t high enough yet to meaningfully invest in a mutual fund, remember that even small, consistent investments can lead to big growth over time. As your income increases, you can increase your SIP amount, so it’s important to start early.
• Don’t just invest in one or two funds. Spread your investments across asset classes and sectors to diversify and reduce risk.
• Clearly define your goals before investing so you can select appropriate funds that are aligned with them.
• Review your portfolio semi-annually or annually to ensure it is still aligned with your changing financial situation and market conditions.
• If you are investing for the long term, you will have to learn to ignore small short-term fluctuations. This volatility can cause anxiety, which can lead to emotional decision-making, ultimately harming your progress.

Conclusion

A mutual fund portfolio is the mix of different mutual fund investments you hold. These instruments offer many benefits such as diversification and professional management, which makes them an attractive option for investors. The five key steps to building a mutual fund portfolio are – Set SMART investment goals, assess your risk appetite and investment horizon, choose funds based on past performance, fund manager’s expertise, fees, and risk-adjusted ratios, diversify your investments, and finally regularly monitor and review the portfolio. 

While these steps make it sound easy, building a portfolio for mutual fund investments is a complex process. A financial advisor can guide you through these steps and help you build a portfolio that reflects your unique financial situation and risk tolerance.

Start building your portfolio with Fincart today and begin your journey to realise all your financial dreams!