Reach your financial goals with mutual funds

     Print Edition: May, 2010

You want to save for retirement. And for your child's education. You also need to save tax. Then there is this long-cherished dream of owning a house. And your plan to upgrade to a bigger car. That's quite a mix of long-term, medium-term and short-term financial goals.

Just as individuals have different goals, there are mutual funds to help achieve these objectives. You could be looking at long-term wealth creation, or a place to park funds in the short term. You may want to diversify into gold or increase your exposure to a certain sector. There is something for both aggressive and conservative investors, short- and long-term goals, all wallet sizes and all age groups.

Choosing the right type of fund is therefore the first step in achieving your financial goals. The choice should be defined by the tenure of the investment, your willingness to take risks, and the liquidity offered by the option. A debt fund, for instance, won't be a good way to save for retirement when you are in your 30s. An equity fund, on the other hand, won't help if you want to save to buy a car next year.

The type of investor you are also plays an important role. If you are easily unnerved by stock market ups and downs, it won't do any good to take on a large equity exposure. But if you can stomach risks, an equity fund can help you reach your financial goal faster. It all depends on how comfortable you are with the risk.

Once you have chosen the category, you can then compare the performance record of the funds within that category to pick out potential winners that can help you achieve your financial goals. Here's how you can use different kinds of mutual funds to reach those goals.

Goal
Plan for retirement

Diversified equity funds
Experts say that one should start planning for retirement as soon one starts earning. You can use mutual funds to build up your nest egg. If you are in your 20s and 30s and retirement is a good 25-30 years away, you can invest aggressively in equity funds. Equity funds are risky but they also have the potential to give high returns. In the long term, equities tend to outperform all other asset classes. In the 10 years between 1999 and 2009, the Sensex gave returns of 17.15 per cent compared with the 12.96 per cent given by gold and 8.3 per cent by government bonds.

If you have chosen your equity mutual fund with care, you have a good chance that it will outperform the broader market and deliver even better returns than the benchmark index.

Best returns in past five years: 29.57 per cent
Category average in past five years: 21.88 per cent

Sector or thematic funds

If you want to add some zing to your portfolio and don't mind taking a little risk, consider sectoral or thematic funds. These funds give investors a focused exposure to one sector or theme and therefore carry more risk than a diversified equity fund. There are now funds for virtually every sector, including banking, FMCG, auto, pharma, energy, media and infrastructure. There are also funds that invest primarily in mid-cap, small-cap or very small cap stocks or in companies that are currently out of favour. A mid-cap fund or a sector fund will suit an aggressive investor. But keep in mind that sectors are cyclical in nature and their performances are affected by different macro-economic parameters. The yearly returns of the BSE sectoral indices in the past five years shows that each year has thrown up new leaders. No sectoral category has been the top performer for more than a year. In 2008, pharma and FMCG funds did better than others. In 2009, infrastructure and auto funds zoomed ahead. This year, it seems tech funds will rule the roost.

Best returns in past five years (Banking funds): 26.25 per cent
Category average in past five years (Banking funds): 24.90 per cent

Asset allocation funds

However, investing should not be a one-time affair. As one grows older and one's financial circumstances and risk appetite change, one needs to review his asset allocation and rebalance his investment portfolio accordingly. Asset allocation funds do this for you by progressively reducing the exposure to volatile assets and shifting to more stable options. Also known as life stage funds, these schemes will typically invest in equities when you are young and shift to bonds, deposits and cash as your age advances. They do away with the need for the investor to periodically check his asset allocation and make changes. That decision is outsourced to the fund manager. In effect, the fund manager books profits in equities on behalf of the investor as he gets older.

Best returns in past five years: 21.57 per cent
Category average in past five years: 15.07 per cent

Systematic investment plans
Stock markets have been very volatile in the past two years. If you don't want to be caught on the wrong foot, take the SIP route where a fixed sum is invested in the fund on a predetermined date every month. Systematic investing helps tide over volatility and, according to experts, is the best way to invest in equities. The magic of SIPs translates into a win-win situation for the investor. If markets fall, he gets to buy more units at a lower price. On the other hand, if the markets rise, the value of his investment goes up. But keep in mind that SIPs work best if you continue investing when the market is going through a rough patch. If you stop investing when markets are down, you lose out on the advantage of buying cheap.

Goal
Child's education and marriage

Balanced funds
The rising cost of higher studies makes it important to start saving for your child's education while she is still in her nappies. If junior is in primary school, you still have a lot of years before he goes to college. You can start investing in a balanced fund which divides the corpus between debt and equities. Balanced funds may not match the scintillating returns of equity funds because they have a lower exposure to equities. But they also carry a lower risk and offer steady returns. Balanced funds are an appropriate option to save for your child's marriage too. The safety is not always at the cost of returns though. The 5-year returns of the best balanced fund are higher than those of the best sectoral fund.

Best returns in past five years: 25.22 per cent
Category average in past five years: 17.38 per cent

Index funds
Talking of safety, there's a category of fund that seldom underperforms its benchmark. Index funds invest in the stocks that constitute their benchmark index in the same proportion as their weightage in the index. As a result, they seldom underperform (or outperform) the benchmark. These funds are best suited for those who don't want to beat the index and are willing to settle for index returns over time. The good part is that for the investor, the passive investing by index funds is cheaper than the churning by actively managed funds. Index funds have lower expense ratios than diversified equity funds and are therefore good bets over the long term.

Best returns in the past five years: 21.88 per cent
Category average in the past five years: 20.39 per cent

Gold funds
Shopping for jewellery is an important expense in a marriage. The way gold prices have risen in the past few years, who knows how much the yellow metal will cost when your little princess ties the knot. You can start buying gold for her marriage in the form of gold ETF units. Each unit is equal to 1 gram of 24-carat gold. Some funds sell units equal to 500 mg. Paper gold is cheap, safe and convenient. When the wedding bells ring for your child, just sell the units and buy gold.

Goal
Plan your taxes

ELSS funds
These funds are like a dream come true for taxpayers. The investment is eligible for tax deduction, the income from dividends and capital gains are tax free and the lock-in period is the shortest among all tax saving options. ELSS funds are diversified equity funds except for the lock-in period of three years from the time of investment and the tax deduction under Section 80C.

Being equity linked instruments, they have given highest returns among all tax saving options. Use them to save tax as well as create wealth but do keep in mind your overall asset allocation. If you are young, ELSS should account for nearly 50-60 per cent of your savings under Section 80C. But if you are in your 50s or 60s, no more than 20-25 per cent should go into these funds.

Best returns in past five years: 28.79 per cent
Category average in past five years: 20.06 per cent

Goal
Earn regular income

MIPs
Earning a monthly income from their investments is one of the most important needs of many investors, particularly those who have retired but whose pension income is not sufficient. Monthly income plans (MIPs) are designed to provide a monthly income to investors by way of regular dividends out of the distributable surplus. These funds are fairly stable because they invest around 80 per cent of their corpus in debt options such as bonds and corporate deposits. The balance 20 per cent is invested in equities to help the fund run ahead of inflation. The result is stable growth which outperforms the returns from debt funds but carries far lower risk than an equity fund. Conservative investors who don't like taking too much risk can opt for MIPs. Investors can also opt for quarterly, halfyearly and annual dividend or the cumulative growth option.

Best returns in past one year: 30.44 per cent
Category average in past one year: 14.84 per cent

Systematic withdrawal plans
Those looking for a regular stream of income can start a systematic withdrawal plan (SWP). This is the opposite of an SIP. A fixed amount is redeemed on a predetermined day of the month and paid to the investor. SWPs are especially useful for retirees because they allow investors to customise the cash flow to their needs. They also help avoid the 14-28% dividend distribution tax (DDT) levied on non-equity funds.

Goal
Saving for the near term

Medium-term debt funds
Not all your goals are long term. You may be saving to buy a car six months later or building up the downpayment for a house. Steer clear of equity-linked instruments if you need the money so soon. A black swan year like 2008 could upset your applecart. Instead, opt for debt funds to save for your short-term goals. These funds invest in bonds and deposits and are completely delinked from the stock markets. They do, however, carry interest rate risks. If interest rates go down, these funds do well. Income funds are a good way to save for financial goals that are 12-15 months away.

Best returns in past one year: 12.50 per cent
Category average in past one year: 5.35 per cent

Short-term gilt funds
To tide over the interest rate risk inherent to funds that hold bonds of long maturities, you can go for short term debt funds. These give lower returns but are less volatile than medium and long-term debt funds. They are useful if you want to park large amount of money for the short term. For instance, the sale proceeds of real estate which is to be reinvested in another property in 3-4 months time. These can also the source funds in systematic transfer plans. While the category has earned less than a savings bank, the best fund has nearly earned double the bank rate.

Best returns in past one year: 7.16 per cent
Category average in past one year: 2.81 per cent

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