The importance of diversification

By Morningstar |  30-03-20 | 

I am 34 years old. Moderately high risk appetite.

My Goals:

  • Retirement: Rs 220 lakh, 26 years
  • Children’s Education: Rs 63 lakh, 15 years and 3 years
  • Children’s Marriage: Rs 120 lakh, after 20 years

How much must I save? What sort of funds? Right now I have SIPs in 4 equity funds of Rs 23,500. Is that enough?

  • Rajnish

The first thing we would like to drive home is the point of diversification. For portfolio construction, asset allocation-based approach (mix of equity and debt) should be followed as it is one of the key determinants of the portfolio’s performance. Higher the investment horizon and risk appetite, higher can be the allocation to riskier asset classes such as equity, which have the potential to deliver relatively higher returns compared to fixed income over the long term.

Given your moderately-high risk appetite and the long time horizon, you may invest with a portfolio mix of about 65% into equities and 35% into fixed-income funds.

The equity allocation can be:

  • Large cap: 38%
  • Mid cap: 8%
  • Small cap: 4%
  • International: 15%

The international equity allocation offers diversification across geographies via exposure to different economic growth drivers and also acts as a hedge against domestic currency risk.

For investment in fixed income, you can consider fixed income funds with a high credit quality portfolio such as Banking & PSU debt funds, Corporate Bond funds, Medium to long term funds.

As your retirement goal approaches (3-4 years before retirement), shift allocation out of equity into arbitrage funds, as they are more tax-efficient than fixed-income funds for shorter holding periods.

Given no information on the market value of existing investments and investing as per recommended asset allocation, you would need to increase the current monthly SIP amount of Rs 23,500 by 8.5% annually to achieve your goals. To achieve a higher retirement corpus, it is advisable to top up your investments whenever you have any excess savings or any windfall gains. The corpus amount has been computed, assuming equity market returns of 11% per annum and fixed income returns of 7% per annum.

Action points:

Since you have multiple goals that are substantial in amount, we suggest you consult a financial adviser.

To evaluate mutual funds across categories, one can look at Morningstar’s analyst views on various funds.

You can check performance of funds here.

To see other aspects, you can look at these tools.

One may also consider Morningstar Investment Packs, offered exclusively on the Paytm Money app, as a solution to help you meet your goals. These investment packs are the outcome of Morningstar Investment Adviser India’s asset allocation and fund selection expertise. Each investment pack has 3 to 5 underlying funds, and are diversified across large-cap, -mid-cap, multi-cap, small-cap equity categories as well as debt categories like liquid, ultra-short, low duration and banking & PSU. Based on an investor’s risk suitability assessment created by Paytm Money, a risk profile (Low Risk, Conservative, Moderate, Growth, and Aggressive) is identified, and an appropriate investment pack is recommended to the investor. These packs are monitored on an ongoing basis and reviewed by Morningstar. Please note, the investment packs are exposed to market risk and do not guarantee the protection of the investors’ money against capital market movements.

What is your view on Global investing? Any global funds? In that light, does it make sense to opt for motilal 100 nasdaq fund? And what is the best way to invest in it ETF or FOF route?

  • Dharam

Diversification is a risk management strategy that involves having exposure to different asset classes/securities within a portfolio, which respond differently to the same set of economic drivers. A diversified portfolio seeks to limit exposure to any single asset or security to lower risk. One should ideally diversify his/her portfolio across geographies, asset classes, and sectors to mitigate risks since concentrated exposures can hurt the fund in times of significant drawdowns in the asset class/sector.

Allocation to global assets offers diversification across geographies via exposure to international economic growth drivers, and also acts as a hedge against domestic currency risk. It reduces the risk associated with an investment in a single country, especially in times of downturns or market volatility, and also helps capitalize on growth opportunities in developed and emerging economies.

  • Motilal Oswal Nasdaq 100 ETF has high concentration to technology stocks, with an exposure of over 40% in the overall portfolio. One should ideally allocate a small portion (< 5-10%) of the overall portfolio to such concentrated funds.
  • Though the ETF option is relatively cheaper, for investing directly into the ETF, investors would need a demat and trading account. This entails brokerage commissions on buy and sell transactions in addition to the annual brokerage account fees.
  • The Fund-of-Fund route involves transacting directly, so you save on brokerage, but involves an additional layer of expense over and above the underlying ETF expense.
  • An ETF offers an investor the flexibility to transact on the exchange throughout the day, unlike transacting in case of Fund-of-Funds, which occurs at the day’s closing price.

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