How does Mutual Funds Work?
How does Mutual Funds Work?
How to build Mutual Funds Portfolio
Building a portfolio of mutual funds is similar to building a house: There are many different kinds of strategies, designs, tools and building materials; but each structure shares some basic features.
To build the best portfolio of mutual funds you must go beyond the sage advice, “Don’t put all your eggs in one basket:” A structure that can stand the test of time requires a smart design, a strong foundation and a simple combination of mutual funds that work well for your needs.
Use a Core and Satellite Portfolio Design
Before building begins, you will need a basic design—a blueprint—to follow. A common and time-tested portfolio design is called Core and Satellite. This structure is just as it sounds: You begin with the “core”—a large-cap stock fund—which represents the largest portion of your portfolio and builds around the core with the “satellite” funds, which will each represent smaller portions of your portfolio.
Use Different Types of Fund Categories for the Structure
With a large-cap stock fund as your core, different types of funds—the “satellites”—will complete the structure of your mutual fund portfolio. These other funds can include mid-cap stock, small-cap stock, foreign stock, fixed income (bond), sector funds and money market funds.
Know Your Risk Tolerance
Before choosing your funds, you need to have a good idea of how much risk you can tolerate. Your risk tolerance is a measure of how much fluctuation (a.k.a. volatility—ups and downs) or market risk you can handle.
Determine Your Asset Allocation
Once you determine your level of risk tolerance, you can determine your asset allocation, which is the mix of investment assets—stocks, bonds, and cash—that comprises your portfolio.
The proper asset allocation will reflect your level of risk tolerance, which can be described as either aggressive (high tolerance for risk), moderate (medium risk tolerance) or conservative (low-risk tolerance). The higher your risk tolerance the more stocks you will have in relation to bonds and cash in your portfolio; and the lower your risk tolerance, the lower your percentage of stocks in relation to bonds and cash.
Learn How to Choose the Best Funds
Now that you know your asset allocation, all that remains is choosing the best funds for you. If you have a broad choice of mutual funds you begin by using a fund screener or you may simply compare performance to a benchmark. You’ll also want to consider important qualities of mutual funds, such as fund fees and expenses and manager tenure.
The old way of asset allocation was “invest for your age,” where your age is a number of bonds in your portfolio. For example, if you are 40 years old, your asset allocation would be 40% bonds and 60% stocks. Today, people are living longer so this asset allocation strategy is not as valid as it once was.
For more on building a portfolio of mutual funds, see these sample portfolio designs: Aggressive Mutual Fund Portfolio Sample, Moderate Mutual Fund Portfolio Sample, and Conservative Mutual Fund Portfolio Sample.
PORTFOLIO CAN ALSO BE CLASSIFIED AS:
a. Growth Fund: –
The Fund invests 85 % in stocks and 15% in Debts. The main objective is to provide long-term capital appreciation.
Income Fund:-
The fund invests 85 % in Debt & 15% in stocks. The Main objective is to Provide Regular Income.
Balanced Fund:-
The fund invest 50-60 % in stocks & 40-50% in debt instruments. The Main Objective is to Provide long-term growth of Capital & Regular Income.
Liquid Funds:-
The fund invests 100% in Government and Public sector bonds, Money market instruments & Corporate debt.
The main objective is to provide an attractive rate of return whole emphasizing Capital preservation and liquidity.
Gilt Fund:-
The fund invests 100% in State/Central Government securities. The main objective is to provide risk-free returns & liquidity.
Sector Fund:-
The fund invests 100% in individual sector stocks. The main objective is to provide growth of capital over a period of time.
Tax saving Schemes:-
The fund invests 100% in stocks. The main objective is to provide Capital Appreciation. Units at this scheme are subject to lock-in period of 3 years from the date of allotment and also rebate of 20% is allowed under section 88 of IT act.
Index Funds:-
Index schemes are a type of mutual fund in which the portfolio weight for each stock will be similar to the index, which they are mirroring, like BSE Sensex or the NSE 50.
The portfolio of these schemes will consist of only those stocks that constitute the index.
Index funds are expected to provide a rate of return over time that will approximate or match, but not exceed, that of the market, which they are mirroring
How does Mutual Funds Work?
