Mutual funds have gained increased acceptance among retail investors over the past few years. There is a pick-up in SIP investments over the past few months, even as the Sensex crossed 60,000 levels. However, a lack of fundamental understanding about mutual funds and misleading financial recommendations often result in investors ending up with a cluttered mutual fund portfolio consisting of under-performing funds, duplicate investments and/or a sub-optimal asset mix. Here is a list of measures to clean-up your cluttered portfolio.
Revisit financial goals
Financial goals refer to the amount of money required to attain various life goals such as accumulating a corpus for your post-retirement life, home loan/car loan down payment and child’s higher education. Start by estimating the monetary value of each life goal after factoring in inflation and the time horizon. Use online SIP calculators for estimating monthly contributions required to create an adequate corpus for each of your financial goals.
Decide your asset allocation strategy
Many investors get influenced by emotions or by family members and friends during the investment decision-making process. However, such investments may not be in line with their time horizon and risk appetite. The first step towards rectifying those decisions is determining your asset allocation strategy. Asset allocation is the process of striking a balance between risk and rewards by diversifying investments across different asset classes like equity, debt, cash equivalents, gold, etc. according to your risk appetite, financial goals, and investment horizon.
For example, as equities hold the potential for outperforming inflation and various asset classes over the long term by a wide margin, the investments for financial goals that mature after five years must be contributed towards equities. Similarly, as equities can be very volatile in the short term, risk-averse investors must opt for debt funds to meet financial goals maturing within three years. Debt funds provide higher capital protection and greater income certainty than equity funds. A well-designed asset allocation strategy will help you to generate optimum risk-adjusted returns for your numerous financial goals.
Figure out underperforming funds
Even while your existing portfolio components match your asset allocation strategy and financial goals, you might find a few of them constantly underperforming their peer funds and benchmark indices. As mutual fund schemes that once performed well in the past can stay underperformers for really long period, it is important for you to identify underperforming funds from your portfolio and redeem them. Compare the performance of your existing funds with their benchmark indices and peer funds every 3 months. Redeem funds that have consistently under-performed their peers and benchmark indices over the past three years.
Restructure mutual fund portfolio to meet financial goals
Once you have identified your financial goals and created the required asset allocation strategy, restructure your portfolio as per financial goals. Recognise funds that match well with your goals and asset allocation strategy. Compare the past performances of selected funds over one, two, three, five and 10-year periods with their peer funds and benchmark indices. This would help in knowing whether such funds have constantly outperformed their benchmark indices and peer funds in all types of market conditions. Remember that while the past outperformance may not be repeated in the future, fund comparisons provide you an idea of how well that scheme might deal with differing market conditions in the future.
When restructuring your mutual fund portfolio, avoid over diversification, as doing so can make tracking difficult. Over diversification can even bring down your entire returns from a mutual fund portfolio. Also, over-diversification within the same fund category or asset class does not make sense as their constituent units would move in the same trajectory – down during bearish market conditions and vice versa.
Periodically check your mutual fund portfolio
After you have decluttered your mutual fund portfolio, make sure you review it at least once in a year. Doing so would help you rebalance your mutual fund portfolio according to the changes in your risk appetite, financial goals, numerous macroeconomic factors and the fundamental attributes of the fund. Periodic review even assists in identifying underperforming funds and correcting deviations taking place due to the previous portfolio asset mix.