Over the past few years, rising investor awareness has led to a significant increase in retail investor participation in the MF industry. However, lack of experience and misleading financial advice lead investors to end up with a cluttered portfolio that usually consists of duplicate investments, underperforming funds and/or sub-optimal asset mix. Here is a step by step approach to clean up your cluttered portfolio:
Revisit your financial goals
Financial goals include accumulation of down payment required for purchasing a home or car, accumulating corpus for post-retirement expenditures, the child’s higher education or marriage, etc. Begin by listing the monetary value of each of these goals after factoring in their time horizon and inflation. Take the help of online SIP calculators to find out the monthly contribution required for creating a sufficient corpus for each of your financial goals.
Determine your asset allocation strategy
Investors often get influenced by emotions and invest in mutual funds suggested by their friends and family. Such investments may not necessarily be in sync with their risk appetite and time horizon. The first step towards rectifying it is to determine your asset allocation strategy. Asset allocation refers to the process of distributing your investments across various asset classes on the basis of your time horizon and risk appetite. For instance, since equities have the potential to outperform inflation and other asset classes over the long term by a wide margin, investment for the financial goals maturing after 5 years should be done inequities. Likewise, given that equities have the possibility of being volatile in the short term, risk-averse investors should go for debt mutual funds to meet their financial goals maturing within 3 years. These funds offer greater income certainty and higher capital protection than equities. A well-planned asset allocation strategy will assist you to generate optimum risk-adjusted returns for your various financial goals.
Identify underperforming funds
Even though your existing portfolio constituents match your financial goals and asset allocation strategy, you may find some of them consistently underperform their benchmark indices and peer funds. After all, mutual fund schemes that have performed excellently well in the past can remain underperformers for a long time. Hence, it is crucial for you to look for the under-performing funds and close them. Compare the performance of your existing funds with their peer funds and benchmark indices for every three months. Redeem funds that have constantly underperformed their benchmark indices and peers over the past 3 years.
Restructure your MF portfolio to meet your financial goals
Once you know your financial goals and the required asset allocation strategy, consider restructuring your portfolio according to your financial goals. Identify funds that match your asset allocation strategy and financial goals. Compare selected funds’ performances over 1-year, 3-year, 5-year and 10-year period with their benchmark indices and peer funds. This will help you in figuring out whether those funds have consistently outperformed their peer funds and benchmark indices in all kinds of market conditions. Note that while past out-performance doesn’t guarantee similar out-performance in the future, fund comparisons will give you a fair idea of how well that fund may deal with varying market conditions in the future.
While restructuring your mutual fund portfolio, avoid over-diversification as this would make tracking complex. Over diversification can also bring down your overall return from the MF portfolio. Also, over-diversification within the same asset class or fund category does not make sense as those constituent units would move in a similar trajectory— that is down during market corrections. Instead, consider purchasing more in few but well-selected funds during such corrections as that will not only help average your purchase cost but also generate higher returns over the long term.
Review your MF portfolio at periodical intervals
Once you have decluttered your MF portfolio, remember to review it at regular intervals, at least once a year. This would assist you to rebalance your portfolio in line with changes in your risk appetite, financial goals, various macro-economic factors, and funds’ fundamental attributes. The periodic review also helps in identifying underperforming funds and rectifying the deviations occurring from the previous asset mix of your portfolio.
*This article was published in Business World on 5th January 2020