I am new to investing. I would to like invest in mutual funds via the SIP mode. Please guide me on how to build a portfolio and the types of funds that it must hold. If the amount is low, won’t the construction of the portfolio be different than if it was much more? I mean, with the amount I have will just 1 fund do or 2 or 3?
Amount per month: Rs 7,000 / Age: 30 / Time frame: 7-10 years / Risk: Moderate.
The very first step is to understand your risk capability and use that as a base. Since you are just 30 years of age and have a time frame of a decade, I shall assume a moderate risk profile (as you yourself have indicated).
Suggestions, based on the assumption.
You can invest with a portfolio mix of about 70% into equities and 30% into fixed income funds.
The equity allocation can be split into large caps (45%), mid caps (10%), small caps (5%), and international equities (10%).
One can also partly allocate the large-cap exposure to lower-cost index funds or ETFs, given the underperformance of actively managed large-cap funds relative to benchmark in recent times. I have also shared my views in Active or Passive: Which is better? Read it to get a better understanding.
For the debt allocation, you can consider fixed income funds with a high credit quality portfolio such as Banking & PSU debt funds, corporate bond funds and medium-to-long term funds.
As your goal approaches, so from 7 years onwards, start gradually shifting the allocation out of equity into fixed income.
How many funds?
The number of funds in a portfolio depends on the asset-allocation mix and the funds chosen to meet that mix. Despite the relatively lower starting SIP amount of Rs 7,000, investability wouldn’t be much of an issue given that the minimum monthly SIP amounts required for most funds is as low as Rs 500.
However, the lower corpus does curtail ability to diversify exposure into more than one fund of the same sub-asset class segment. Initially, you may opt for flexi-cap and large & mid-cap funds instead of allocating separately to large, mid and small-cap funds. Do read Too many funds with the same style and How to pick the right fund.
As your income grows, you can look to increase your monthly SIP amount to amass higher wealth at the end of your horizon and then look to allocate to pure large/mid/small funds to gain better control over your sub-asset class allocation.
Principles behind the suggestions
International equity allocation offers diversification across geographies with exposure to different growth drivers, and a hedge against currency risk. I have written about this in more detail in How to invest abroad.
A portfolio should have a mix of equity and debt, 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.
This is the most favoured asset class for wealth generation over the long term, with the potential to deliver superior inflation-adjusted returns compared to fixed-income. Though equity is more volatile than most asset classes with even possibility of a capital loss over the short-term, the risk of capital loss diminishes as the holding period increases.
Other aspects.
Since you are new to investing, you must also consider other issues.
To avail tax deductions (under the old tax regime), you may look to invest some portion of the investible corpus into ELSS funds (lock-in of 3 years) under the equity allocation and into PPF, NSC, etc. under the debt allocation.
Do read The Tax Planning Guide for further guidance.
You can also consider the National Pension Scheme (NPS) for investing towards your retirement goal, which is a low-cost product offering additional deduction of Rs 50,000 under sec 80CCD (1B) over the above the Rs 1.5 lakh deduction under Section 80C.
It is recommended to have an emergency corpus in place worth at least 6 months of expenses, and a term plan and a health cover in place to safeguard your family against any untoward incident. You should evaluate your portfolio at periodic intervals with regards to your stated goals, and make suitable adjustments accordingly, if needed. Read 4 questions on Emergency Funds answered.
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