I am 33 and would like to invest for my retirement at 50. I would like to invest 1 lakh per month and plan to invest aggressively. Can I go ahead with 2 mid-cap and 2 small-cap funds? Should I have a flexi cap, though I have a long-term perspective?
At the onset, I would like to appreciate the fact that you are considering investing for your retirement at a relatively early age. This is a smart move because the earlier one starts and gives his money sufficient time in the market, the better the outcome.
All investment portfolios must follow an asset allocation-based approach, as it is one of the key determinants of the portfolio’s performance. The exact mix of equity and debt will depend on how far away the investment goal is. In your case, since the goal is a good 17 years away, we can consider a higher allocation towards equity.
First, let me answer your specific queries.
Diversification is the key while constructing a portfolio, as it cushions the portfolio against any adverse movements of a single security/asset class. One should be reasonably diversified across asset classes; market cap (large/mid/small), sector and style diversification (value/growth) when it comes to equities.
While mid- and small-cap funds do have the potential to deliver higher returns (relative to large caps) over the long term, they are also among the most volatile. For instance, in 2020, the average drawdowns witnessed by these fund categories were -26.3% (large cap), -28.9% (mid cap) and -32.2% (small cap). Therefore, allocating your entire portfolio to mid and small caps may not be the most prudent approach, even though the goal is 17 years away. Do read Why must a large-cap fund be a core holding?
Flexi-cap funds have the leeway to invest across market caps without any restrictions on segment-wise allocations. This freedom gives asset managers to invest in a free-flowing manner based on their reading of the market. As long as your broader asset allocation is in place, flexi-cap funds do make a sound fit in the portfolio. In fact, I answered a reader's query in Do you really need a flexi-cap fund? You can read it for a better perspective.
My suggestions.
For an aggressive risk profile, you could look at an allocation of 85% to equity:
- Large cap: 45%
- Mid cap: 15%
- Small cap: 10%
- International funds: 15%
- Gold funds and fixed-income funds: 15%
The allocation to international equities offers diversification across geographies with exposure to diverse growth drivers, and a hedge against the depreciation of the rupee.
The allocation to fixed income funds and gold during heighted choppy markets brings down the volatility of the portfolio and enables you to have some dry powder in your kitty if you need to take incremental additional positions into equities.
The allocation and number of funds in a portfolio should be a function of the recommended asset-allocation mix and the funds chosen to meet that mix.
Action points.
- Within each market segment choose funds which have different styles of investing (Growth, Blend and Value). Each of these will perform in a distinct way and should therefore ensure your portfolio is not impacted by one particular style if that were to go out of flavor. You could also consider a mix of both active as well as passive funds.
- Invest into funds and AMCs which have a consistent long term track record. Diversifying across fund houses helps to reduce concentration risks. Also try to ensure the overlap between funds are low.
- High expense ratios do tend to eat a way returns which a fund generates and should therefore be one of the parameters you look at when you consider investing in a fund, but not the only parameter. SEBI has marked the upper limit for this at 2.25% of the average asset under management.
- Our research shows that over a 10-year period, investors are best served to identify consistently managed funds and stay invested. Investing basis recent performance can be counterproductive, resulting in missing of critical months of performance in both the newly invested fund(s) as well as the exited fund(s). Therefore, once you narrow down on the funds you wish to invest in, stay invested in it for the long term.
- Monitor the portfolio at least once in a year and rebalance it accordingly, if the allocation of one particular asset class increases /decreases substantially.
You can view our fund analysis and details on fund portfolios here.
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