What Kind of Funds Should You Have in Your Investment Portfolio?

What kind of funds should you have in your portfolio?

You should clearly know the rate of return you need to meet your goals.
More importantly, you should know how much risk you are willing to take in hard times to earn the returns you are targeting.

This will help you avoid more risk than necessary. The answers to these questions are not as easy as they seem, especially to the second question. It is easy to build a portfolio to achieve both these needs, if you know what they really are.

People often look at returns, ignoring the risk component. Most of us want an investment with high returns and no risk or less risk. Just like cigarette smokers who choose to ignore the warning that ‘Cigarette Smoking Is Injurious To Health’, investors, too, will look the other way when it comes to the caveat that mutual funds are subject to market risk. Investors tend to focus only on returns when investing in stocks and mutual funds. They must also look at the following:

• What kind of stocks is this fund invested in?
• Is this concentrated in a few stocks or sectors?
• What is the standard deviation and beta (something that your advisor should be able to explain) of the fund?
• What is the portfolio turnover of this fund? (does it buy, sell and churn its stocks very often)?

There are reasons why one fund earns more than another and the reasons can be any of the following:

• High exposure to certain sectors or stocks
• Calls taken by the fund manager have been spot on
• Portfolio is concentrated or has a higher turnover
• Market timing

However, the same reasons can go against the fund and its performance can suffer. Just because a scheme has been a hot performer does not mean it will continue to be one. Evaluate the performance over extended periods of time and not just over a quarter or so.

If your objective is income and capital protection, then a debt fund is more appropriate. You can also look at hybrid options with 80% debt and 20% equity (monthly income plans). Short-term funds that are required in a few weeks or months should be parked in liquid plus funds or floating rate funds. Finally, avoid costly mistakes such as chasing hot funds or top performers of last year and acting on the basis of some rudimentary talk about fund size or promises about unrealistic performance.