Thursday, January 20, 2011

7 steps for selecting a mutual fund portfolio

For most small investors, the best way to get your feet wet in the stock market is to build a mutual fund portfolio. Why? Because there are a bewildering array of stocks traded every day. Stocks classified under ‘A’ group, ‘B’ group, ‘S’ group, ‘T’ group, ‘Z’ group can confuse any investor. Which ones from among the thousands should one add to one’s portfolio?

Stock selection requires basic knowledge of economics. Understanding concepts of supply, demand, inflation, recession, stagflation, repo rate, reverse repo rate, CRR, SLR, commodity prices, oil price, foreign exchange rates, GDP growth and how they may affect the performance of a sector and individual stocks can be a daunting task that requires perseverance and experience to master.

Then there are accounting concepts one needs to learn. Debit, credit, depreciation methods, inventory calculation methods, deferred taxes, assets, liabilities, capital expenditure, working capital requirements, profit, loss, cash flows, share holding patterns have to be added to an investor’s dictionary.

To make things even more complicated, there are ratios to be analysed and different valuation methodologies, and for those who like to look at graphs and charts – a variety of technical analysis concepts and patterns. (If you are investing in individual stocks without learning and applying most of the above-mentioned concepts, you are probably not making much money!)

There is a simple way to get the benefits of stock investing (beating inflation and getting tax-free returns) without spending a lot of time and energy in mastering concepts that may not come easily to you. Build a mutual fund portfolio. Leave it to the fund managers to do individual stock selections, and let them decide about when to buy and sell. The only downside to buying mutual funds is that you are handing over the control of your investments to some one else, and indirectly paying him for the privilege.

There are several types of funds to choose from. Equity funds, sector funds, index funds, debt funds, hybrid funds, liquid funds, open-ended funds, close-ended funds. Not to forget ETFs. Then there are growth options, dividend reinvestment options and dividend payment options. (The combination you choose should take into account your tolerance for risk, requirement of regular cash inflows and tax savings.)

How to find your way through this bewildering maze of funds and options? Here are 7 steps to build a mutual fund portfolio:

  1. Visit There are many other sites that you can visit, but I have been using this particular site and it provides all the information I need.
  2. Scroll down to the ‘Research Tools’ section of the home page. In the ‘Funds Selector’ window, select - Type:Open End; Category: All Equity (Exc. Sector Fund); Returns over: 5 years; Returns: Above 10% Gainers; Ratings: 5 star and 4 star. Click on ‘Get Data’.
  3. About 55 funds will get listed. From these choose about 10-12 equity funds based on low expense ratio and double-digit 1 year returns (two right-most columns).
  4. Repeat step 2, but with Category: Equity: Tax Planning. Choose 2-3 funds from the list of 7.
  5. Repeat step 2 once again, but with Category: Hybrid: Equity-oriented (better known as ‘Balanced fund’). Choose 2-3 funds from the list of 8. You can choose other categories of funds also. This is a suggested list.
  6. The number of equity funds in the portfolio should get pruned to 3; and 1 each from tax planning and hybrid for a total of 5 funds – which should be more than enough for a fund portfolio. The pruning will require some work. At the bottom of the home page of is a link list of all fund houses. Click on the ones you have chosen. E.g. if you have chosen HDFC Top 200, click on ‘HDFC’ and then from the bottom of the list of HDFC funds, click on ‘HDFC Top 200’. Scroll down to ‘Portfolio Summary’ and click on ‘View additional holdings information’. List out the top 10-12 holdings. Repeat the process with all the chosen funds in your list. Short-list 2 large cap funds, 1 mid/small-cap fund, 1 hybrid fund and 1 tax planning fund (for less risk, select an index fund instead of a mid/small-cap fund) based on minimum common holdings for maximum diversification. In other words, if three funds have 7 common stocks among their top 10-12 holdings, short-list only one fund out of the three. If you don’t follow this process, your equity holding in the funds may get lopsided towards a few stocks.
  7. Visit your nearest broker, fund houses, or CAMS centre to fill-up KYC and application forms (or go online) and start investing regularly.


Jasi said...

hahaha, I did not know it was so easy. You were almost sounding like Sanjeev Kapoor giving a recipe for making money. :)
Jokes apart, it was actually like that only. The post is the essence of your writing. The way you make everything look so easy for all of us. Hats off Sir and please do keep the good work up.
It is such a pleasure to see a new post on your blog and it never disappoints :)

Thanks and regards

feltra (Raman R) said...

Dear Subhankar ji,

Your teachings are very lucid and really helpful to the retail investor/trader (as compared with some other blogs which only showcase their own brilliance).

For example I have not seen words like those in the 2nd and 3rd paras (in this post) in any other place. People who just jump into so-called Fundamental Analysis and think they can become the next WB ought to read those lines every day.

So far, I had not considered mutual funds but thought that I would "learn" how to invest/trade on my own. Sadly results are lacking in that dept! After your post, I will at least visit valueresearchonline regularly and if market comes down, certainly invest in a few funds.

Thanks for your contributions & Best Regards,

Subhankar said...

@Jasi: Thanks. You are always very generous with your compliments.

@Raman: Appreciate your comments.

Self-assessment is very important for achieving success - whether in your life, career, or investments.

Making mistakes is a part of the learning process. Accepting that, and not repeating earlier mistakes is a sign of maturity.

Joe said...

Dear Sir,

This is an excellent post. You make it sound so easy, yet it is perfectly logical.

Only a Master can make explain complicated issues in a very simple manner.


Subodh Joshi

Subhankar said...

Thanks for your comments, Subodh.

Step 6 is not as easy as it may seem. In fact, it requires a fair amount of work.