A Comprehensive Guide to Building and Managing a Mutual Fund Portfolio

In just ten years, the Asset Under Management of the Indian Mutual Fund Industry has increased more than five times, from 7.60 trillion as of December 31, 2012, to 39.89 trillion as of December 31, 2022. Many mutual funds have provided double-digit gains over the previous ten years, riding the tide of India’s tremendous economic expansion. Since they invest across dozens, even hundreds, of different stocks, bonds, or other securities, mutual funds aid in quick diversification. Furthermore, historical evidence suggests that large groups of stocks typically handle market volatility better than single stocks.

Hence, for investors who do not have expertise in stock selection, mutual funds provide an attractive investment option.

It is important to be invested in the right kind of Mutual Fund to gain maximum returns. Let us look at how to create a diversified Mutual Fund Portfolio.

1. Define the three principles of Mutual Fund investing

2. Asset Allocation

After determining these three points, the next step is asset allocation:

There are many different types of mutual funds available that are made to fit various investor objectives. The following factors can be used to categorize mutual funds:

3. Fund Selection

Kindly refer to this article for a detailed discussion on what factors to consider while choosing the best-performing fund: https://tavaga.com/blog/mutual-fund-analysis/ 

4. Investment and withdrawal options:

Investment can be in two days:

1. Lump sum
2. SIP: Invest a fixed amount in mutual funds step-by-step, monthly or quarterly over a period of time, thereby averaging out your cost of investing and benefiting from the power of compounding.

Withdrawal: 

1. Lump sum
2. Systematic Withdrawal Plan (SWP): Allows an investor to withdraw money from an existing mutual fund at predetermined intervals. SWP helps investors to create a regular flow of income from their investments.

The ideal number of funds in a portfolio

To build a balanced portfolio, it’s crucial to have the appropriate number of funds. A portfolio with too few investments may become dangerously concentrated while a portfolio with too many investments will be difficult to manage.

Depending on your investment amount, you might invest in 3-4 funds for an equity portfolio and 2-3 funds for other categories like debt, balance, or gold.

Of course, the mix will change depending on your investment horizon and risk tolerance.

Here is an indicative list of mutual funds according to risk, category, composition, and time horizon:

When to rebalance a Mutual Fund Portfolio?

Portfolio management doesn’t stop with the creation of your portfolio. It’s important to monitor funds on an ongoing basis. 

Predetermined Period: Rebalancing back to your target allocation bi-annually or at least annually is important. 

Extreme Change: You may want to rebalance sooner if there is an extreme change in value in some part of your portfolio or a change in your life circumstances. For example, Covid19 pandemic and the Russia-Ukraine war.

How to rebalance a Mutual Fund Portfolio?

Remove consistently underperforming funds: 

Track the performance of a portfolio at least for 1-2 years before making a decision. Compare the fund’s performance based on the risk and return matrix to that of its peers and own benchmark. Get rid of it if there is persistent underperformance.

Deviation-based rebalancing:

If your allocation deviates outside of a specified tolerance band, rebalancing is triggered. Let’s assume that the tolerance range is +/-5%. In a 70-30 scenario, your portfolio will need to be rebalanced if it falls below 75% or rises beyond 25%.

These actions will not only assist in rebalancing your portfolio but also in reducing the number of funds and clearing up the mess.

Systematic Transfer Plan: 

This plan allows the redemption of funds from one mutual fund scheme to be invested as fresh investments into another scheme. While STP is a great way to manage volatility, one has to be careful of tax liabilities occurring due to STP. Tax Liability occurs when you redeem units from a mutual fund and have capital gains. 

Equity funds: Redemption for transfer of funds within 1 year of purchase will be taxed under the Short Term Capital Gains Tax at 15% and after 1 year, gains of more than Rs. 1 lakh will be taxed under the Long Term Capital Gains Tax at 10%. 

Debt funds: Redemption for transfers within 3 years of purchase are taxed as per individual tax slab and after 3 years are taxed at 20% after accommodating for the benefit of indexation.

In conclusion, building a mutual fund portfolio is a smart investment strategy that can help you diversify your portfolio, reduce risk and achieve your financial goals. By following a systematic approach, conducting thorough research, and seeking professional advice, you can create a well-rounded mutual fund portfolio that aligns with your financial goals and risk tolerance.

Disclaimer: Above piece is only for information purposes. Please consult a SEBI Registered Investment advisor before taking any investment decision.

Tavaga is everything you need to start saving for your goals, stay on track, and achieve them in time. 

Download Now: