More and more retail investors in India are becoming aware of the benefits of saving and investing through mutual fund systematic investment plan (SIP). While deciding to do a SIP is a great start in your journey to financial freedom, you may still fall short of your financial goals if you do not investment in right mutual fund schemes.
There can be multiple reasons why you may still not reach your financial goals, despite saving and investing through SIPs. If you take too little risk, then you may not reach your financial goals because the returns will not be adequate. If you take too much risk, you may be risking your financial future to the vagaries of the stock market. If you invest in mutual fund schemes which underperform for long periods, then the returns may not match your expectations. In this article we will discuss, how to do SIPs in the right mutual fund scheme.
Define your financial goals
The first and a very important step in the journey to your financial goals, is to clearly define your financial goals. We usually have multiple financial goals in life e.g. buying a house, children’s education, children’s marriage, financial independence in retirement years etc. The time lines for these goals are different.
You can plan your life goals here
It is not enough to say I need to have so many lakhs or Crores by the age of 50; all goals in life are important. You need to clearly define, how much you need for each goal. You should always factor inflation when defining your goals; otherwise, you will be woefully short of your goals. It is unwise to apply average inflation rates for all goals. Certain items in our consumption basket like education, healthcare etc. have much higher inflation rates and you need to plan accordingly.
Suggested reading: 5 signs which indicate you may face financial troubles later in life
Know your risk taking appetite
The next step in a structured financial planning process is to determine your risk capacity. Risk capacity depends on multiple factors. The timeline to your goal is an important consideration; if you have a long timeline then you can take more risks and vice versa. The stage of your life is another important factor in determining risk capacity. The younger you are, higher is your risk capacity because you have more productive (from an income standpoint) years ahead of you.
Risk taking capacity reduces with age. Risk capacity also depends on factors like your liabilities, your existing assets, supplementary income sources (e.g. dividends, interest, house rent), number of dependents etc. Your attitude towards risk, also known as risk appetite, is also a factor in investment decisions. Some people are risk taking by temperament, while others are risk averse. While risk capacity should be the most important factor in investment planning, your attitude towards risk will also invariably influence your investment decisions.
Asset allocation
The third step in investment planning is asset allocation. Asset allocation is the mix of different asset classes like equity, debt, gold etc. in your overall asset portfolio. Optimal asset allocation should be determined by your risk capacity in the stage of life you are in; optimal asset allocation will determine whether you are taking the right amount of risk.
Asset allocation may not be relevant for short or medium term goals, but is integral to long term investment success. Asset allocation is the most ignored aspect of investment planning among retail investors because most of us are driven by fear and greed in making investment decisions. In bull markets investors are usually gung-ho on equities and neglect debt investments; this leads to the portfolio being too much risky. When panic grips investors in bear markets, they rush to exit from equity for safe investments. Since SIPs are usually long term investments, you should be mindful of how your investment will impact your total asset allocation and plan investments accordingly.
For example, when you are young, your optimal asset allocation should be overweight on equities. Therefore, for long term investments, it is fine to invest in equity funds. On the other hand, if you are 50 years old, your optimal asset allocation should be balanced between equity and debt. In that case, even for long term investments (e.g. 5 years or 10 years), it may be more prudent to invest in hybrid funds (e.g. balanced funds).
Select the fund categories
The final step of investment process is the fund selection. There are thousands of mutual fund schemes in the market and selecting the right fund for your SIPscan seem like a daunting task. However, if you follow the steps discussed above, your task will become much simpler.
As discussed earlier, your investment should depend on the financial goal and asset allocation considerations. If your goal timeline is long (5 years or longer) and your risk capacity is high, you can narrow down fund selection to equity mutual funds; depending on your risk appetite, you can further narrow down your fund selection to large cap equity mutual funds or midcap equity mutual funds or a mix of both. If your risk capacity is moderate, then you can invest in hybrid mutual funds (e.g. hybrid aggressive funds). If your risk is low or moderately low, you can invest in income funds or debt oriented hybrid funds for starting your SIPs.
Selecting the best performing funds
Once you narrow down to the fund category, your fund selection task becomes much simpler, but even within each fund category there can be 50 to 100 schemes. You should first eliminate the below average performer funds in the bottom two quartiles, in terms of long term (3 to 5 year) performance. Now within the average performers, you should look at funds which have the best long term track record and also fund manager’s continuity. If a top performing fund has a new fund manager, look at the fund manager’s track record of managing other funds of similar type.
You may select the top performing mutual funds from any category here.
If you follow a methodical approach, you will be able to select the right mutual fund schemes for your SIP and will be well placed for investment success.
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