One associates mutual funds with equity, mostly.
But the fact is that MFs provide a range of options for different risk profiles, beyond just equity funds.
An MF is an investment vehicle that pools money/investible surplus from many investors and invests based on the scheme objectives.
The money, thus collected, is invested across different asset classes.
Based on such investments the fund is categorised either as equity, debt, bond, liquid or hybrid fund.
Equity funds and bond funds are actually not comparable and are in fact two ends of the MF spectrum.
An equity MF basically invests in shares listed on stock exchanges.
Equity funds can be further categorised based on the kind of shares held -- large cap, mid and small cap.
Bond MFs invest in debt/bond instruments.
Based on the average maturity of the bonds which the fund invests in, it can be short-term or long-term bond funds.
We look at how to choose between equity and debt mutual funds based on your risk profile - what kind of mutual funds are best suited for what kind of investors:
How to choose
Investment in any asset class depends on the risk appetite of the investor.
Equity MFs can be considered by those who are ready to invest for the long-term and willing to take higher risk in their portfolio. It also has the potential to deliver higher returns.
A bond fund can be considered by those with a moderate risk profile looking for medium to long-term debt instruments for investments.
However, an ideal scenario would be to have both, that is, equity and bond funds in one’s portfolio.
Mix and match
Ideally, investors should have a mix of both equity and debt MFs in their portfolios. The proportion should be based on their risk appetite.
Moderate and high-risk investors
For investors willing to take moderate to high risk, around 50 to 55 per cent of their portfolio can be a combination of large, mid and small cap category of mutual funds.
Someone who is a beginner can start with large cap category of funds since it comes with low risk compared to mid and small category of funds.
Around 15 to 20 per cent can be parked in balanced category of funds.
Include gold MFs or Exchange Traded Funds also in the should also in the portfolio, since it offers a hedge against stocks.
About 15 to 20 per cent of the portfolio can be allocated to bond funds. Some allocation can also be made to liquid funds.
These are funds that invest in short-term debt instruments and provide good liquidity with very low interest rate risk.
For risk-averse investors
For risk-averse investors, equity portion should be limited to 20 to 25 per cent of the total portfolio.
Also, large cap mutual funds should have higher weightage compared to mid and small cap category of funds.
Balanced funds can be considered for investment, but the exposure to balanced funds should also be limited to 20 per cent-25 per cent of equity portion.
This can be further reduced when one wants to completely avoid all risks associated with equity markets.
Gold should be a part of the overall portfolio; with 10 to 15 per cent of the portfolio comprising investments in gold.
Debt MFs are best suitable for risk-averse investors. For such investors, 30-35 per cent of the portfolio should comprise debt MFs.
Churn, but be choosy
- A mix of equity and bonds will give good returns in the long-term
- Bond funds would do well in volatile times, and equity funds will do well in positive economic cycles
- Consider the current economic and interest rate cycle before investing in bond funds
- Use a short-term bond fund or liquid fund when interest rates are rising and when interest rates are falling use long-term bond funds
- Diversify equity fund investments across various market cap funds depending on the risk appetite.
The writer is a certified financial planner
