Q1. Defence sector is coming up and there are some mutual funds as well investing in the defence companies. Is it wise to invest in a cyclical sector specific mutual fund for the long term?
Sectoral funds invest in companies that belong to a specific sector, for example, Sectoral-Banking funds will invest in shares of banks and financial services companies. The key risk to such funds is the lack of diversification. Such funds can generate high returns and losses based on the specific sector's outlook.
The timing is very crucial, as investors will have to time entry and exit. Hence, it will require more time to analyse and understand sectors as compared to other diversified funds. Further, let’s say you invest 10% of your portfolio in a specific sector, and that sector outperforms your other funds by 10%, then your overall portfolio is only going to get impacted by 1.0%.
These funds can ideally be advisable for someone who is already in the market for a very long time and has seen some cycles of ups and downs in the market. Somebody who hasn't been in the market for long, or doesn't have time to track the market daily can avoid such funds and invest in diversified funds.
Q2. Are small cap mutual funds bad for long-term investing? Should I go for more stable mutual funds like large caps for a 30-year investment horizon?
Mutual fund categories are different, and their suitability differs from person to person. Large-cap, for example, is suitable for someone who wishes to invest in stable companies with decent returns, on the other hand, small-cap is for someone who seeks high returns from growing companies and can withstand volatility and price fluctuations.
Before investing, one needs to evaluate their risk profile and goals. Let's say, your risk profile indicates that you are an aggressive investor, then you can consider allocating some portion of your investments to small-cap funds. However, be prepared for higher fluctuations in terms of risk reward for small-cap funds and stay invested for more than 7 years.
Avoid major allocation into small-cap funds and prefer diversifying across Index, large, mid and small cap funds. Since a 30 years investment horizon is a longer period, investing in multiple categories under equity with periodic monitoring of scheme and asset allocation is suggested.
Q3. I am looking to park some money in an FD for at least 3 years. I heard that the RBI is going to raise rates. Some banks have already started raising FD rates. Should I book the FD now or wait for a couple of months to get better rates? Also, will the differential in rates now and two months later make a difference? I am looking to invest ₹2 lakh in this FD.
RBI may increase the rate depending on the current market condition or it may maintain the status quo for growth consistency. Let's take a scenario where the RBI has raised the rates by 0.50% or 50 bps. However, it is at the discretion of banks to pass on the benefit to their clients. Even if they increase the FD interest rate by 0.5% then the impact will be ₹1,000 per year for 3 years (0.5% x ₹2 Lakhs). The net impact will be lower even if we consider the taxation.
Considering the uncertainty around the rate hikes by RBI, further hike on bank FD rates, and the negligible impact, it is prudent to start now.
Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.
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