Let us face it! Most of us hold too many mutual funds! Either we started with Rs. 1000 SIP in five funds or we saw new “good funds” and decided to “have some exposure to it”, or we stopped investing in underperformers but left the investment in the old fund untouched. After a few years, our portfolio is cluttered with funds from the same category, and with funds having huge portfolio overlap. If this is your problem, then here is how you can easily trim your portfolio with just a few simple steps.
How many are too many? Now, I hold six mutual funds. On this face of it, it looks like too many. But there are two aspects most people fail to understand. I own different mutual funds for different goals. So I hold three funds per goals. You may then ask, “why don’t you manage both your goals with the same three funds?”. Well, that would be messy because of the “first-in, first out” rule for units and these goals have different time horizons. It is possible to use the same funds for all goals See for example Financial Goal Planning with a Unified Portfolio. However, I prefer to keep them separate and invest separately.
So the next question is, “why have three funds for a goal?, Why not reduce it to two or one?” Well, here the portfolio size matters. If you had ten lakhs, will you put all of that in one fund or split it? What if you had one crore? We will discuss this size issue below.
Step 1: Get your basics in order
- You need specific goals
- You have to decide how much to invest in equity and how much in fixed income for each goal
- You need to decide how you are going to vary equity allocation as you keep investing
- You need to decide on the build of your equity portfolio.
For steps 1,2,3 you can directly download the Freefincal Robo Advisory Software Template, punch in your numbers and get ready-made results.
The build of your equity portfolio
I don’t care whether you are 20 years old or 40 years old, whether your portfolio has 20% equity or 80% equity. Always ensure that you have 60-70% of large-cap stocks. This can be in index funds if you are just starting out. Rest can be in a midcap fund as explained yesterday.
So the essential build I would recommend is: 70% large caps and rest in mid and small caps.
Step 2: Decide on the number of equity mutual funds based on portfolio size and personal comfort level
So once you decide the market cap breakup, the number of equity funds necessary has to be decided. As mentioned above, if you have a 10 lakh portfolio, you probably would like to split it among three funds? If that portfolio grows to one crore, it is still okay to have only three funds (don’t imagine how you will behave when you are a crorepati. As money grows, investors tend to become comfortable with concentration risk)
The big problem is that people take a SIP of Rs. 5000, split it into five and start five SIPs. That is stupid. Up to Rs 50 lakh can be held in a single mutual fund IMO. So if you have Rs. 5000 to invest, invest in one fund!! You can add another fund when you are able to invest more.
- If you are going to invest less than Rs. 10,000 a month in equity funds, just one fund will do!
- For people with less than 25 lakh in equity mutual funds, I would recommend two mutual funds only
- Above that and only above that, a third fund can be added to reduce concentration and performance risk.
- A fourth fund when that one crore double and so on (if uncomfortable)
This step is key to maintain a trim portfolio
Yeah, I can hear you ask, “but if I invest in just one fund, how will my equity portfolio be diversified?” Well, what is your hurry for diversification? Start with one large cap fund and when you can invest more, add a new fund. No big deal.
But Nifty blend = 50% Nifty 50 and 50% Nifty Next 50 = two funds no? Look kid, if you are going to invest a small amount, simply choose the Nifty 100 Equal Weight Index and keep it simple. Two funds are necessary only when you are going to invest 50K and up a month.
What is the hurry? Start with one fund and as your investment increases, add one more if necessary. Wait, I digress. This post is not for young earners, it is for older investors already having a cluttered portfolio. So you need to look at your equity portfolio value and decide on the number of funds. Unless you are a multi-crorepati, three funds will work for most.
Steps 3: Decide on the nature of each of your funds
So, now that we have decided on the number of equity funds in our portfolio, the next step is to decide their nature. There are many combinations possible. Let me list just a few (for 3 fund portfolios)
- Aggressive Hybrid
- Small-cap (some people – people who have not seen market crashes – cannot sleep without small caps in their folios, so let us satisfy them)
- Aggressive Hybrid
- Aggressive Hybrid
- Aggressive Hybrid
- Balanced Advantage
- Aggressive Hybrid
You can build your own combinations, these are only examples. The large-cap funds can be active or index.
Step 4: Understanding the trim down process
So let us assume we hold 10 funds (following a youtube viewer comment). How can we get it down to three funds? It is important to recognise that the trim process need happen immediately, especially now as equity LTCG is taxed. It is important to systematically trim over a period of 6-12 months.
Step 5: Identifying the ‘keepers’
Make a table with fund names in one column and their portfolio weights. In your 1 lah portfolio, if a fund has a current value of 10k, it is a 10% weight. For example:
ABC Fund 5% weight 12% XIRR
XYZ Fund 3% weight 9% XIRR
and so on.
Out of the 10 funds, decide which of the three funds you are going to hold choosing a combo as listed above.
Step 6: Shifting money
Once you have identified the keepers, all your future investments must be only in those funds. In the remaining 7 funds, identify all units which were purchased more than one year ago. We will call these seven funds as laid-off funds.
As explained earlier, Use this “market crash” to clean up your equity fund portfolio tax free, if the current NAV of a laid-off fund is lower than its Jan 31st NAV, then all units purchased more than one year ago are still tax free and you can immediately redeem those and once the money hits your bank account, invest in one-shot into the keeper funds (NO STP nonsense). To understand this taxation better, watch this video
If the current NAV of a laid-off fund is higher than its Jan 31st NAV, then you still have a one lakh per financial year tax-free limit (combined for all your laid-off funds). So you can shift that much to the keeper funds.
Do this exercise each quarter as more and more units become older than one year. Of course, the exit load has to be accounted for too. For most funds, the load is zero if the unit is older than one year. As you keep doing this, the weights of the keeper funds will increase and your laid-off funds will decrease. It is important to not buy any more funds during this period!!
Step 7: What if the keeper fund underperforms?
In future, if you are not satisfied one of your keeper-funds, stop investments, find a new one and start investing there. All this, of course, is nothing but commonsense but requires tremendous discipline to see through and discipline cannot be purchased on a black-Friday deal! Give the above steps a try and let me know how it went.
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