Cleaning the house or office desk might seem a cumbersome process, but you feel satisfied once it’s done. Similarly, having a well-pruned mutual fund (MF) portfolio makes it more organized and easier to manage.
Spring-cleaning your MF portfolio is a step-by-step process that is tied to your financial goals:
1. Goal alignment
First of all, check if your investments are in sync with your financial goals. List all your financial goals along with the financial target to be achieved over a time-frame. While some might be long-term oriented (child’s higher education or retirement), others like a down payment for a house or car will be short-term oriented.
If you have become a parent recently, you might want to add a new financial goal which says "child’s college education". Similarly, achieving a financial goal will relieve you of its responsibility.
2. Asset allocation
Once, you have a rough idea of the existing financial targets, work out your monthly contributions towards achieving them. Ideally, all long-term financial targets (over five years) can be achieved with equities (12-14% p.a.), while the rest could be attained with debt funds (6-8% p.a). It’s a function of how much do you understand asset class risk, the time in hand, and how much you can save.
So, work out the optimal equity-debt mix. Long term goals will have a greater allocation to equity while short term goals will almost all be fixed income-based.
Equity portfolio of investors has come down sharply in the recent equity market correction. If you have surpluses, park it in a liquid fund and transfer it systematically into equity funds, till you restore the equity-debt mix. However, if you don’t have any surplus, tweak the asset-allocation mix of existing SIPs in favour of equities till you hit the target.
Portfolio rebalancing should be done once in a year, or as and when necessary depending on your goals and time left to achieve them.
3. Fund choices
Once you have a grip on the asset allocation, check if funds in your portfolio are fulfilling your investment objective. Some funds might have changed their fundamental attributes after the 2017 Sebi reclassification process. Some multi cap equity funds, for instance, have reclassified themselves as midcap funds. If these funds are no longer fulfilling your investment needs, consider replacing them.
Then, weed out the non-performers. Are these funds able to beat the benchmark returns over the long-term? For equity funds, look at relative performance over five and seven-year time frames. Don’t hanker after returns and give funds a fair chance. Look for repetitive downgrades from accredited fund rating agencies.
Some funds might have changed their fundamental attributes after the 2017 Sebi reclassification process. Some multi cap equity funds, for instance, have reclassified themselves as midcap funds. If these funds are no longer fulfilling your investment needs, consider replacing them.
4. Less is more
Are you holding more than 20 equity funds in your portfolio? Perhaps, you are better off with indexing then. Take, for example, if you own a large cap fund, it’s tantamount to owning 22 per cent of BSE 100 stocks. And if you make it three, it becomes 34 per cent, assuming you invest all in the right funds. Moreover, there is a 37 per cent portfolio overlap (common stocks as a percentage of the overall portfolio) by investing in equal proportion in these three funds.
As you own more funds, you indirectly end up owning more stocks.
As a thumb rule, hold only about four to five equity funds with distinct investment strategies and low overlap. Two large caps and two multi caps, for instance, should suffice for building long-term wealth for most investors.
Tax and more
Also, while exiting funds, assess if there are tax-inefficiencies or exit loads to minimize. Short-term capital gains are taxed at 15 per cent for equity funds, while it is 10 per cent for the long-term. However, by limiting long-term capital gains up to Rs 1 lakh in a financial year, you can completely save on taxes. Conversely, work out if you are sitting on any capital losses that can be set-off.
MF portfolio needs to be tagged to your financial goals. Its spring cleaning involves a dynamic process where you calibrate asset allocation, weed out laggards and minimize tax liabilities. And like office desk cleaning, you need to do it every now and then.