There are about 12 equity fund categories, 16 debt fund categories, and 5 hybrid fund categories. If that is not enough, almost all AMCs have a scheme on offer in each of these categories. So, for small investors, looking to pick some good funds, there are hundreds of mutual fund schemes to choose from!
This can be utterly confusing for investors. And if you get your fund category selection wrong, the chances are that you will end up with negative investment outcomes. So, picking the right fund category (even before the exact scheme) is very important.
One of the major factors in deciding the asset allocation of an investment strategy is the time horizon. It is not the only factor, but an important one. And investors have different goals with different time frames.
So, let’s see how to go about picking the right fund categories for different time horizons like 0-3 years, 3-7 years and 7+ years. The answer will also depend on what kind of investor we are considering (conservative, balanced, and aggressive).
Fund categories for 0-3 years
A time horizon of less than 3 years is clearly short-term. So, there is no need to invest in equity funds. It should be purely debt. Here is how different investors can invest money for the short period of 0-3 years:
- Conservative / Balanced Investor - Liquid funds, Ultra-Short Duration funds
- Aggressive Investor - Ultra-Short Duration, Conservative Hybrid or Arbitrage Funds (better for those in higher tax slabs)
Fund categories for 3-7 years
This time horizon allows investors of a certain risk appetite to take a bit of risk. Within the time frame of 3 to 7 years, one can take more risk the longer the tenure is. So first one needs to decide the equity allocation and then the right categories.
For conservative and balanced investors, for 3-5 years, about 25-30% equity can be considered. For 5-7 years, a slightly higher equity allocation is fine. For aggressive investors, for 3-5 years, about 40-50% equity can be considered. For 5-7 years, 60-75% equity allocation is fine as well.
Now coming to the categories.
- Conservative / Balanced Investor (for debt part) - Ultra-Short Duration funds, Short Duration Funds, Conservative Hybrid Funds, Banking and PSU funds
- Conservative / Balanced Investor (for equity part) - Aggressive Hybrid Funds
- Aggressive Investor (for debt part) - Ultra-Short Duration funds, Short Duration Funds, Conservative Hybrid Funds, Corporate Bond funds
- Aggressive Investor (for equity part) - Flexicap funds, Large-cap funds
Fund categories for 7+ years
For most investors, this time horizon qualifies as the long term. This is a long enough period to have a reasonably large equity allocation.
For conservative investors, 30-40% equity can be considered. For balanced investors, 40-60% equity can be considered. And for aggressive investors, around 75% equity allocation can be considered. Now let’s see what fund categories can be chosen from:
- Conservative Balanced Investor (debt) - Short-Duration funds, Banking and PSU funds, Conservative Hybrid Funds
- Conservative Investor (equity) – Passive Largecap funds, Aggressive Hybrid funds
- Balanced Investor (equity) - Flexicap funds, Large-cap funds, Large-&-Midcap Funds
- Aggressive Investor (debt) - Low Duration Funds, Short-Duration funds, Corporate Bond funds
- Aggressive Investor (for equity part) - Flexicap funds, Large-cap funds, Large-&-Midcap Funds, Midcap & Smallcap Funds, International Funds
So that is how you can pick a suitable fund category for your requirements. Also, just picking the right fund category doesn’t complete your job. You need to pick funds too within the category. Some funds will be good and others will not be great. So, you need to know how to pick the right funds also.
If you can do it on your own then good for you, else take help from investment advisors to help plan your finances in addition to recommending suitable fund categories and schemes as well.
Dev Ashish is a SEBI-Registered Investment Advisor and Founder (Stable Investor). He provides fee-only financial planning and investment advisory services to small and HNI clients across India.