Once goals are set, use this framework to choose mutual funds
Which funds should I invest in?
Posted on 08 Jun 2021
Author: Sayan Sircar
3 mins read
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Once goals are set, use this framework to choose mutual funds
In this post, we address the biggest problem that many investors are concerned with: which fund to invest. The solution is the 3-fund portfolio.
The 3-fund portfolio is a very simple portfolio that uses diversified low-cost index funds to get as much exposure as possible to stock and bond markets. This concept has been popularized by the followers of Vanguard founder and investor advocate John Bogle.
The 3-fund portfolio may not necessarily have exactly 3 funds but the concept can be used by Indian investors quite easily to invest for their financial goals.
Having a simplified portfolio is one of the axioms of personal finance?.
📚 Topics covered:
- What is there in a 3-fund portfolio
- Why choose this portfolio and what returns to expect
- Can more funds be added?
What is there in a 3-fund portfolio
The simplest 3-fund portfolio has 2 asset classes and 1-2 funds in each
This is the simplest possible portfolio that can be chosen for any goal beyond 5 years until the end of retirement. For a goal closer than 5 years, the equity component should be zero depending on the risk profile. Typically for long term goals of 15 years or more, provident fund (EPF, PPF, VPF, Sukanya Samriddhi) can be used as long as there is enough holding in open-ended debt funds to allow rebalancing.
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Why choose this portfolio and what returns to expect
This portfolio is simple, has extremely low cost and is easy to maintain. The returns will be very close to the overall stock market since only index funds are recommended in the equity section. It is very difficult to beat an index fund due to both cost and the human element that otherwise causes poor returns in the portfolio of active fund investors.
Such a portfolio, when rebalanced regularly with debt, will be both low maintenance and suitable for DIY investors who do not want the hassle of worrying about which fund to invest next.
Can more funds be added?
Typically International funds and Gold may also be added to the portfolio. The right reason to do this is not “increase returns” but instead risk reduction via diversification. Ensure a robust and frequent rebalancing plan is prepared and followed if international equity or gold is needed.
Read more: How to choose a gold mutual fund
Any investors want to get exposure to midcap and smallcap funds as well in their equity portfolio. While this is certainly possible, it again increases the amount of active decision-making (how much exposure?, SIP or Lump sum in small-caps?), timing considerations (is this the right time to invest in midcaps?) etc to creep into the decision-making process. While this may be an exciting pastime for many, the remaining investors will be better off with simpler portfolios. An investor wishing to know more is advised to review this post on core-satellite portfolio construction. Once funds have been chosen, please look at this detailed post regarding whether same or different funds are to be chosen for different goals.
This post specifically covers investments for investors either saving for or already in retirement.
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