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Mutual funds that everyone must have

While each individual's goals and risk profiles are different, some basics are needed in almost all portfolios

Everyone’s portfolio is different. That is how it should be. Why? Because your risk profile and financial goals are different from the next person’s. That doesn’t mean there wouldn’t be anything in common. In fact, the basics are usually the same. So, for instance, all of us have a savings bank account. Most salaried employees would have an Employees’ Provident Fund or a National Pension System investment. Few may have a consultant agreement with their employers that gets them a service tax-deducted lump sum cheque at the end of every month, on which they pay tax.

Likewise, when you invest in mutual funds (MFs), there are certain basic schemes that need to be there in almost everyone’s portfolio. These are schemes that serve basic needs—be it to build an emergency fund or to save taxes every year. Let’s take a look at them.

Liquid funds

We told you some days back why your money box needs a liquid fund (http://bit.ly/1LnYItq ). But given the importance of this product, it is worth your while to read a bit more about it. Liquid funds are short-term MF schemes meant for short-term needs. They are an alternative to your savings bank account. “A liquid fund cannot be used for wealth creation. It is only used for regular expenses," said Yuvaraja, a Bengaluru-based MF distributor.

Your money in a savings bank account fetches about 4% pre-tax interest per annum. Some banks may offer more, but usually with a minimum deposit rider. However, liquid funds have returned 4-5% returns on a 6-monthly basis, consistently since 2011.

On returns alone, liquid funds score over a savings bank account.

Moreover, dividends declared by liquid funds are subject to a dividend distribution tax of 28.84% (including surcharge and cess). On the contrary, your bank interest gets taxed at income tax rates (30.9% for the highest tax bracket; including surcharge). For an investor in the 30% tax bracket, a dividend plan works out to be slightly more tax efficient. Even for investors in lower tax brackets, liquid funds can prove to be beneficial on a pure return basis.

“Liquid funds are ideal for all those investors who keep money in excess of one month of their expenses in their savings bank account," said Vishal Dhawan, founder and chief executive officer of Mumbai-based Plan Ahead Wealth Advisors.

After tax, your returns from savings bank account drops to about 3-4% (depending on how much your bank pays), but liquid funds still earn you 5.5-6%, if you are in the highest tax bracket.

Tax saving schemes

Another type of funds that can be found in most of our portfolios is an equity–linked savings scheme (ELSS). This is an equity diversified scheme that offers tax deduction benefits under section 80C of the income-tax Act, up to a maximum limit of 1.5 lakh a year.

But does everyone really need an ELSS? “No," said Dhawan. “It makes sense only for those investors who still have tax deduction limits available; someone who has not exhausted the 1.5 lakh section 80C benefits," he said. Since this tax deduction can be made use of through various means such as home loan payments, tuition fees, employees’ pension fund and other contributions, ELSS is not compulsory, he added.

Shyam Sunder, managing director, PeakAlpha Investment Services Pvt. Ltd, looks at it another way. He said that investors tend to look at tax incentives as their primary objective. “That’s wrong. The right way to look at investments is to first look at what you want to do with it eventually, and then look at the tax aspect," he said.

If you have dependents and already have a life insurance policy, you can then look at an ELSS. But if you don’t have a life insurance policy, you need to take a life cover first, said Sunder. Another scenario is if you are “heavily exposed" to equities and have a significant amount of equity holdings, then risk becomes a concern. In that case also, one must avoid ELSS, he said. But in most cases, it’s a “slam dunk obvious choice".

International funds

Most of the money that we invest is invested within India. But it is common knowledge that MFs invest abroad as well. These are typically fund of funds (FoFs) that collect money from investors here and then collectively invest the sum abroad in an internationally listed MF scheme. FoFs can invest in schemes that invest either globally or just in emerging or developed markets across the world.

Most advisers recommend international funds to diversify a portfolio. “Most people become uncomfortable when it comes to investing abroad. They are happy to keep all their money in India, whether they buy real estate, fixed income, equity or whatever else. But that sort of an approach brings in the single-country risk. For the sake of asset allocation, geographical diversification is also important," said Dhawan.

Take a look at how Indian equities (S&P BSE Sensex in dollar terms) have performed when compared to the US (S&P 500 index) and Europe (MSCI Europe). In the past 14 years, India has outperformed the other two regions nine times; and S&P 500 index has outperformed four times.

Diversified equity funds

Of all the actively-managed MF schemes on offer, none is simpler than this type of funds. Those who wish to start investing—you may have just joined the work force, for example— must start putting away some money in a diversified equity fund.

However, a diversified equity fund can mean either a large cap-oriented fund or a multi-cap fund (a scheme that puts money in companies of all sizes). Anup Bhaiya, managing director and chief executive officer, Money Honey Financial Services Pvt. Ltd, suggests that a multi-cap fund is a better option “because it is relatively more diversified, has a fair share of large- and mid-sized companies and tends to do better across markets". That, however, doesn’t mean that such schemes can escape volatility. But a multi-cap fund is diversified “well enough" to build a foundation to your portfolio, he said.

Believe it or not

A Bengaluru-based financial planner advises investors to invest in a pharmaceutical sector fund, irrespective of the investor’s risk profile. B. Srinivasan, director, Shree Sidvin Financial Services and Investments Pvt. Ltd, said he does not recommend a pharma fund because he expects it to outperform, but because of post-retirement medical care.

Srinivasan said investors tend to redeem their funds prematurely, at the “slightest provocation at times".

To make sure that investors build a sizeable corpus and at the same time, to prevent them from “touching" their post-retirement medical and assisted care corpus, he makes his clients invest in a pharma fund.

But why only a pharma fund? Why not, say, a diversified fund? “That way, I label this fund. It’s a pharma fund. There is a certain medical-like tune to it. Besides, pharma companies grow roughly at (the rate of) medical inflation over the long run. So, there are multiple well-managed pharma companies in which a fund can invest," he said.

Labelling folios is not such an isolated concept, though. Many financial planners do it, in different ways, to ensure that investors don’t withdraw their money prematurely and use it only for the goal for which they have been saving that money for.

“The idea may sound hilarious, but it actually works," said Srinivasan.

We don’t have a view on this unorthodox strategy. Mint Money doesn’t recommend sector funds as part of Mint50, our curated list of funds.

The strategy may work though if your planner recommends it and has put a mechanism in place to monitor it. But labelling a folio, in whichever way possible, to ensure you use it only for the specified goal, works.

Therefore, choose your strategy wisely but get the basics right.

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