When I was new to mutual funds I use to regularly ask questions like, “which is the best mutual fund?”. But now when I have gained a little knowledge and a little experience, questions like these seem irrelevant, at best they are incomplete.
But still a lot many people ask these types of questions. So to make things a little easier and more clear I am going to address the question “which mutual fund category to choose?”. You should first determine whether you want a mutual fund for equity or debt portfolio. For equity portfolio, you can select a fund belonging to one of these categories, Aggressive Hybrid Funds, Large Cap Funds, or NIFTY/SENSEX Index Funds. If you want to take more risk for more returns you can add a fund from these categories, NIFTY NEXT 50 Index Funds or Large & Mid Cap Funds. For debt portfolio, you can choose a Liquid Fund and if you have a long-term goal and are ready to take more risk for more return you can choose a Money Market Fund.
Mutual Fund Categories for Equity Portfolio
The equity mutual fund category is probably the most popular category of mutual funds. A lot of information about how to choose an equity fund is freely available, but sometimes so much information confuses the investor. Maybe this why I have seen people acting as a collector of mutual funds rather than investors. Thus I am going to suggest a limited set of categories that are enough for a retail investor.
First of all, I would like to remind you that you should have ZERO exposure to equity if your goal has a term of 5 years or less. And, even for long-term goals, you should not invest 100% in equity.
So, the categories you should consider, or it is better to say, should stick to for equity portfolio are:
- Aggressive Hybrid Funds
- Large Cap Funds
- NIFTY/SENSEX Index Funds
Now don’t start collecting one fund of each of these categories, finalize one fund belonging to one of these categories. If you want to take a little extra risk for a better return you can add one fund belonging to one of these categories:
- Large & Mid Cap Funds
- NIFTY NEXT 50 Index Funds
In conclusion one fund from first three categories is enough, you may add one fund from other two categories but it will add to the risk.
How to Finalize One or Two From These Five Categories
Determine whether you want to go with a Passive fund or an Active fund.
Passive funds are easier to choose, are less expensive and are less risky as no additional risk is taken in quest of giving returns more than the benchmark.
Active funds have the potential of giving more returns than passive funds, but they are riskier and the data shows that the majority of active funds fail to do so.
So, if you choose passive funds your choice is simple.
NIFTY/SENSEX Index Fund
NIFTY NEXT 50 Index Fund (if you want to take more risk for more return)
In case you want to go with active funds you have two choices, Aggressive Hybrid Funds, and Large Cap Funds.
In theory, Large Cap funds are riskier but also have the potential of generating more returns. But, in reality, Aggressive Hybrid funds have given returns similar to Large Cap funds on many occasions and that too at a lower risk.
So you should go with
Aggressive Hybrid Fund.
But if you choose Large Cap Fund for any reason you can go ahead.
Large & Mid Cap Fund (if you want to take more risk for more return)
Mutual Fund Categories for Debt Portfolio
There are 16 categories of debt mutual funds as per SEBI, add to it the limited amount of information available, this makes it quite difficult for a new investor to settle on a debt fund.
Although debt funds are sometimes advertised as being risk-free, this is far from the truth, credit risk and interest rate risk are not be overlooked. Thus the criteria for a debt fund category is low credit as well as interest rate risk. Among the category satisfying these conditions, I choose the category with decent return potential.
So for your debt portfolio, you should select a fund belonging to the Liquid Funds category.
In addition, if you have a long term goal and you can take a little extra risk you can look into Money Market Funds.
What about other categories, are AMCs idiot to offer them?
No, they are not idiots but their aim is to earn more profit, not to give you safe returns. AMCs don’t have kids, spouses, aged parents, etc. but you have. AMCs can book losses and close down funds, you can’t.
Please remember you are a retail investor your capabilities of handling losses is also limited. Don’t be a fool with your money.
So according to you we should just have 4 mutual funds?
No, you should have just three, 2 for equity 1 for debt that too if you are ready to take on extra risk, otherwise just 2.
1 NIFTY/SENSEX Index Fund
1 Liquid Fund
1 Aggressive Hybrid Fund
1 Liquid Fund