Mutual fund products can cater to different investment needs. However, not all needs and financial goals may require you to pursue highest returns. While building a mutual fund portfolio, it is important to consider your expectations and match the product that is able to meet your specific need most efficiently. Here are some requirements that you may have and funds that are best suited to meet them.
Need to buy gold
Suitable fund: Gold funds and gold ETFs
Gold exchange-traded funds (ETFs) and gold funds helped many investors make good returns when gold prices appreciated sharply in the last one year.
These funds can be used to accumulate gold for a future need, such as gifting for your child’s wedding. “For investors who may need gold at some point in the future, gold funds provide the most efficient way to hold it without the worries of purity, storage, insurance and other worries that come with holding physical gold," said Suresh Sadagopan, founder, Ladder7 Financial Advisories, a Sebi-registered investment advisory firm.
Typically, households buy gold jewellery over time with the intention of using it when the need arises. However, more often than not, the styles change and a lot of value is lost in making charges and on account of purity when the jewellery is changed for new sets. A gold fund or ETF allows you to buy gold without compromising on purity or going through the trouble of safe storage or sacrificing any value on account of making charges. “You accumulate units over time and when you need to buy the jewellery, you just have to redeem the gold units at the current price of gold. The money can then be used to buy the latest style of jewellery without any loss of value," said Sadagopan. The price of gold at which the units will be redeemed and the price at which the jewellery will be purchased will both be the prevailing price of gold.
Need to fund education
Suitable fund: International funds
Saving for children’s education is an important long-term goal most investors have. The number of students going out of the country to pursue education is also steadily going up every year.
One of the worries you may have when saving for a foreign education is the impact of exchange rate movements on the cost of the education at the time of funding. It leads to uncertainty in the goal value. A depreciation in rupee means that for the same dollar value, the cost goes up in rupee terms and the money that you have accumulated may be insufficient when you actually need to fund your child’s education abroad.
One way to protect the corpus against currency risk is to use international funds offered by mutual funds to accumulate the corpus. Since these mutual funds invest in foreign currency denominated stocks, say, stocks listed on the US stock exchanges, they act as a hedge against currency movements for Indian investors. When the education expenses have to be met, the units in the international fund can be redeemed. The redemption amount will include the impact of exchange rate and this sets off or nullifies the impact of currency on the cost of education.
“Education is an important goal for parents and it is very important to have certainty so that there is no hiccups in funding the goal. There is comfort in knowing that the required funds are available in dollar terms when it is required," said Sadagopan, explaining the willingness to trade off lower returns from international funds for the predictability of goal value.
“Even from a pure return basis, international funds have given good returns in the last 10 years. This is augmented by 3.5-4% per annum due to depreciation in the rupee on an average if you consider a long investment period and this significantly pushes up returns in rupee terms," he added, countering the argument that investing in Indian markets give higher returns which can be used to offset the impact of currency.
Need for liquidity
Suitable fund: debt and arbitrage funds
Investors hold funds in the savings bank account to manage their regular expenses, as reserve for emergencies, or for large expenses that have to be met in the near future and other such needs. The primary need for this portion of the portfolio is ease of access and protection of the capital.
Liquid funds and overnight funds are cash management products that you should consider as an alternative to the savings bank account since they offer comparable liquidity features along with better returns and negligible risk.
The Securities and Exchange Board of India (Sebi) has prescribed tight regulations to mitigate liquidity and credit risks in these funds that make them safer products.
The choice between the two would depend upon the period for which the money is likely to be held since Sebi has now mandated a graded exit load on redemption from liquid funds before seven days. “For any money that you hold for an investment horizon of seven days to, say, two months, liquid funds are the best option," said Gajendra Kothari, managing director, Etica Wealth Management (P) Ltd.
For investors who have shorter holding periods, overnight funds will be more suitable. The instant cash facility of up to ₹50,000 every day along with online facilities to transfer money to and from these funds gives investors the ease of use and liquidity with better returns. “Investors are conscious that their money can work harder than just lying idle in a savings or current account," said Kothari.
Ultra-short duration funds can be used for parking money for slightly longer holding periods of two to six months. With much higher returns than liquid funds, they can be used to accumulate money for regular, larger, predictable expenses, such as education fees, taxes and vacations for which money should ideally be set aside periodically till it is due. Ultra-short and low duration funds can also be used to transfer funds from long-term equity and other investments as goals come closer. Since they are open-ended funds they can be withdrawn as required without any penalty.
Arbitrage funds are another category of funds that can be used to park funds with minimum risk and with the tax efficiency of equity funds as an added benefit. These funds invest in the cash and derivative segment of the equity markets for the same security to lock in the price differential in the two markets. Arbitrage funds do not carry the risks associated with investing in equity because the equity positions are hedged. Any fall in the price of the security which will lead to a loss in shares that have been bought in the cash market is offset by a gain in the short position in the futures market. They are taxed as equity funds with short-term capital gains being taxed at the rate of only 15%. Arbitrage funds and liquid funds pay dividends at frequent intervals to reduce the impact of capital gains taxes on withdrawals. The dividend distribution tax (DDT) applicable on dividends paid is also lower at 10% for arbitrage funds as compared to 25% for liquid funds.
Not all mutual fund products should be selected only for their ability to earn a good return. Look beyond the returns to other advantages that they bring to the way you are able to manage your finances. Look for products that will help achieve your objective in the most efficient manner.