Investing in Mutual funds: Forming a Portfolio
Studies show that asset allocation has as much as 90 percent or more impact on a portfolio's returns. Given below are the various types of mutual funds and the different types of assets which they invest in. These are presented in decreasing levels of risk:
1. Stock or Equity Mutual Funds
These mutual funds invest in stocks of companies. Some of these mutual funds have a more specific focus, like a specific country or sector. Some invest in 'categories' of stocks such as small caps, or blue chips, or emerging markets. Some are general or 'global' and invest in a variety of sectors and categories.
Generally, the more specific the focus on the mutual fund, the higher the risks that are involved.
2. Bond or Income Mutual Funds
These mutual funds invest in bonds and other fixed income instruments. There is great diversity of products in these categories but generally, they tend to be lower in volatility (risks) and returns. These are great investments for income preservation.
3. Balanced Mutual Funds
These mutual funds comprise of both equities and bonds. Their aim is to give investors a moderate level of risk and return.
4. Money Market Mutual Funds
These funds invest in short term money market instruments comprising "I Owe Yous" of various kinds. These are considered 'safe' mutual funds, because there is very little volatility in the value of these instruments. However, their returns also tend to be low. The costs of acquiring them tend to be very low, which is a plus point.
If you have a
- Short investment horizon (e.g. between 2 - 5 years), you should hold a greater proportion of less risky mutual funds.
- Medium investment horizon (e.g. between 6 - 10 years), you can hold a mixture of higher risks mutual funds, and lower risks mutual funds.
- Long term investment horizon (e.g. above 11 years), you can afford to have a greater proportion of higher risks mutual funds.
By varying your portfolio, and by shifting your mutual funds gradually towards lesser risks products as your investment horizon nears, you can optimize the levels of returns given the level of risk that you are comfortable with.
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