If you frequent personal finance websites like Relakhs, you are probably familiar with the concept of mutual funds, and have probably invested in them. If you’re not a mutual fund investor, you still probably have heard of mutual funds, thanks to the AMFI’s (Association of Mutual Funds of India) Mutual Funds Sahi Hai campaign, aimed at educating and spreading awareness about the concept and working of mutual funds.
With Bollywoodesque ‘How To guides on investing in mutual funds’, the AMFI’s drive to increase investments in Indian mutual funds is a determined and vigorous campaign, which makes complete sense because AMFI is an association of SEBI-recognized Mutual Fund Houses, and it works in their interest to have more Indians invest in mutual funds.
In India, there is no shortage of websites and How To Guides that provide information on how to invest in direct mutual funds, sign up for a KYC (Know Your Customer document), and how to pick a good basket of funds to invest in. The last part is important because each investor has to invest in a portfolio that makes sense for them, taking into consideration their income, financial goals, age and risk-appetite.
I’ve Invested in Mutual Funds, set up a few SIPs. Now what?
Great question. While it would be nice to forget about your investments and come back to them in seven years to pleasantly discover that they have doubled in rupee value and beat inflation rates, that unfortunately, wouldn’t be a prudent decision.
It’s important to keep periodic track of your investments to see how they are doing, and to do some reallocation along the way to move your funds according to your changing life circumstances and market performance. This is called portfolio rebalancing, and it’s very important that you have the most up-to-date and accurate information about your portfolio so that you can make the best decisions.
If you spend hours tabulating your investment information in a spreadsheet, be careful about calculation errors. We’ve all made them. I have too, and once discovered that I was tens of thousands of rupees poorer than I thought I was!
If portfolio tracking takes too long for you, it probably means that you’ll lose interest in doing it often enough, and you won’t be able to make informed decisions about your investments.
Mutual Fund Portfolio Tracking & Important Metrics
There are different kinds of mutual funds, depending on which type of assets the fund invests in. For instance, equity funds are mutual fund schemes, where more than 65% of the funds are invested in equity shares of domestic companies. Debt funds invest in fixed income instruments such as Corporate and Government bonds, are lower-risk investment options for those looking for better interest rates than their bank’s savings accounts/ fixed deposits.
Keeping a track of fund allocation is important to ensure that it is in line with your risk tolerance and future money requirements. As your portfolio appreciates over time, the ratio of equity:debt could possibly change.
For example, if you start with a 50:50 equity:debt allocation, and if you leave your portfolio untouched for a year, it is possible that by the end of the year, the allocation could have changed to 60:40 based on the rate of appreciation of the funds.
Examples of Fund Allocation:
It’s important to understand the different kind of funds and make sure that you are invested in funds that align with your current income levels, age and financial goals. Following are some general guidelines that you can use when deciding on your fund allocation (but please remember, everybody’s situation is unique):
- Young Person at the start of their career, with a secure monthly income: 100% equity -> 50% in large caps, 30% in small/mid, 20% in sectoral. If you know you have a cash flow requirement in the near future, move the fund to a debt or liquid fund once the fund is out of exit load.
- Middle-aged Person approaching retirement: If your source of monthly income is not going to be as frequent once you retire, you have to make sure that your money will be available to you when you need it. This is a good time for you to start moving the quantity of required money into safer debt funds.
This is why portfolio rebalancing is important. Take time at periodic intervals (at least once in an year) to see the fund allocation of your investments, and ask yourself if you are on track to meet your goals. Do you have about six months of expenditure in liquid funds for an emergency? If you have a big expense coming up, should you start moving money into a debt fund? These are some of the important checks.
XIRR (Internal Rate of Return)
XIRR is the rate of return applicable to your investments, taking into consideration all the transactions (such as SIPs, redemptions, transfers) that you have initiated since you first purchased a fund. It is a good measure of the return on your investments, and is much more indicative of performance than absolute return because the latter doesn’t reveal what the cost of your investment is. Also, it’s hard to compare returns from one fund to another in absolute returns because the amount invested and time-frames are often different. If you invest through SIPs, XIRR is a more accurate indicator of your returns than CAGR. (Related Article : ‘Five important formulas to calculate returns on investments‘)
The equation used to calculate XIRR is as follows:
V0(1+r)t0 + V1(1+r)t1 +….. = Vn
Where V0 = value of money at first cash flow (when you first bought the fund, or the value at the date that you want to start the calculation of XIRR from)
r = rate of return (which is what we are trying to determine)
t0 = time between today and the date of the first cash flow
Vn= value of money today.
For instance, if we purchased INR 10,000 of a fund on June 1st 2017, V0 = 10,000
Vnwould be the value of those funds today, with appreciation.
Each time there is an additional purchase of funds or redemptions, we add more V’s to the formula, and then we solve to determine the value of r, which gives us the XIRR value. What this calculation allows us to do is prorate the gains on funds depending on the time frame that we have held them for.
(Related Article : ‘How to calculate Rate of Return on Investments using XIRR function in MS-Excel?‘)
Once you’ve invested in a fund, it’s important to see whether your fund manager is picking the right assets for the portfolio. Two factors that impact the performance of your portfolio are market timing (how the market was performing at the time that you invested) and the selection of assets in your portfolio.
Market timing is something that investors cannot fully control. We don’t always have money on hand when the time is ripe for investment, and our investment decisions are often influenced by our own capital flow, which doesn’t always correlate with the market.
What we do have control over is our decision to move to another fund if we have reliable evidence that the fund we are currently invested in is not performing well. To do this, it’s important to nullify market timing, and ask ourselves what our returns would have been if we had, instead of purchasing in a particular fund, invested the same amount of money at exactly the same time in a benchmark index. For instance, how would your portfolio have performed if you had put all your money in the BSE Sensex instead of investing in “X” fund?
To do this, you will have to compare the XIRR of your funds against the XIRR of a benchmark index for the same period of your time. This will show you if your funds are outperforming the market, as compared to a similar asset class/category.
To demonstrate this, let us take a sample portfolio and look at the equity funds in it. For each fund, we will assign a benchmark index (as an example) depending on the type and size of the fund:
Please note: these graphs show sample data only. Now let us take a look at the XIRR of these funds for the past one year, and compare it with the XIRR of the benchmark index for the exact same time, including the identical pattern of cash flows as in each fund.
In this graph, the green bars show the fund’s XIRR over the past year (so for instance, as of 23rd January 2018, they show the fund’s XIRR from 23rd January 2017), and the grey bars show the benchmark index’s XIRR over the exact same time period. Remember, the reason why the same benchmark XIRR can be different for each fund is because it replicates each fund’s transaction pattern, with varying investment amounts and cash flows.
Here, for instance, we can see that the HDFC Capital Builder fund has outperformed the BSE 200 by 13.32%. That’s great news!
Mirae Emerging Bluechip fund, on the other hand, has under-performed the BSE 200 by 8.03%. Does this mean you should leave the fund? That depends. Some funds take a longer time to outperform the market, and your decision to leave depends on you. Think about how soon you need this money and whether you’re willing to take a bet on this fund. If funds are consistently underperforming the market, it’s time to move!
This Seems like a Lot of Information and Hard Work!
Yes, it is, especially if you are investing in direct mutual funds, and are investing using different portals and fund house websites. This fragmentation across platforms can cause a lot of “tracking and calculation fatigue” and make you feel like giving up.
However, portfolio tracking and rebalancing is important, and can be easy once you get the hang of it. It’s important to rebalance your portfolio to avoid a “drifting portfolio” that can you put you in a riskier situation than you had intended.
The mutual fund industry in India is evolving (albeit slowly) to provide individual investors with better technological tools and more transparency to help them make more informed decisions about their investments. This is good news! Today, there are multiple platforms in India to invest directly in mutual funds and to track the performance of your portfolio, either by uploading statements, or automatically. Choose the one that makes the most sense for you and keeping tracking the portfolio to make sure you’re investing wisely.
This is a guest post by Pranshu Maheshwari of SimpleMoney.
Author’s Bio :
Pranshu is the CEO and Founder of SimpleMoney, a Y Combinator backed startup that allows investors in Indian financial markets to keep track of their investments for free.
He was previously founder of Prayas Analytics and Metricboy, and launched SimpleMoney in 2016 to solve a problem that frustrated him everyday – the problem of tracking all his investments across multiple portals. Pranshu is an alum of the Wharton School of Business.
Kindly note that ReLakhs.com is not associated with Simplemoney. This is a guest post and NOT a sponsored one. We have not received any monetary benefit for publishing this article. The content of this post is intended for general information / educational purposes only.
(Image courtesy of pakorn at FreeDigitalPhotos.net) (Post first published on : 23-Jan-2018)