Best mutual funds for all your different financial goals


Investment advice can sometimes sound repetitive. Most readers who write to us for guidance are advised to invest in mutual funds. We believe mutual funds are a one-stop shop for nearly all investment needs. Whether you want to save to buy a car this year or put away money for your child’s higher education 10 years from now, whether you want to save tax or get regular income in retirement, mutual funds are by far the best investment vehicles to reach these goals. They offer everything that an investor seeks: low charges, ease and flexibility of investment and withdrawals, diversification, lower taxes, transparency of investments and tight regulation.

Our cover story looks at 10 categories of mutual funds which can be used to save for different goals. The goals have been categorised into three broad time horizons: short term goals of 1-3 years, medium-term goals of 4-6 years and long-term goals of more than 7 years. We have listed the top five schemes in each category, based on the mutual fund ratings by Value Research. Value Research rates funds on the basis of their risk-adjusted performance against their peers in that category. The best funds in the category are assigned a five-star rating. Though most of the funds in our lists are five-star rated funds, some categories also have four-star rated schemes. This would happen if the direct plan of the same fund was rated five star. The direct plan is not in the list because we looked at equity and balanced funds with at least a five-year record.

Curiously, a large section of the investing population is aware of mutual funds but prefers to stay away. Most of them are not sure how to pick the right funds. We hope our cover story will help you identify the best fund for your goal.

The other big hurdle is the paperwork. To make it easy for investors, fund houses have launched online facilities. The introduction of e-KYC has made the process even simpler. “The e-KYC allows one to invest in a mutual fund in a matter of minutes,” says D.P. Singh, Executive Director and CMO, SBI Mutual Fund. Happy investing.

Best funds for short-term goals: These funds score over bank FDs
Though returns are market-linked, short-term debt funds are fairly stable and best suited for goals that are 1-3 years away. They are also more tax efficient than FDs.

What the investor wants
*Safety of capital
*Ease of investment
*Flexibility of withdrawal
*Better tax efficiency

Though bank deposits are the preferred instrument to save for short-term goals, debt mutual funds can be a better alternative. They are more tax efficient if held for more than three years and can even generate higher returns for investors. You could be saving to buy a car, go on a foreign holiday or even putting away money for your child’s college admission. Meet Bengalurubased Waman Prabhu, who is saving to buy a car in about 2-3 years. A short-term debt fund will give him greater flexibility and better tax efficiency than bank deposits.

While Prabhu plans to start SIPs in a short-term debt fund, investors can even put a lump sum amount in these funds. Jenny D’Souza has saved about Rs 7 lakh for her daughter’s foreign education. She might need the money in 16-18 months, maybe even longer. A short-term debt fund will give her the required flexibility without tying her down to a fixed tenure.

Are debt funds safe?
It is a fallacy that debt funds cannot lose money. Their returns are linked to interest rate movements. When rates fall, the value of the bonds held by the mutual funds goes up, and vice versa. Interest rate cuts in the past six months have led to a rally in long-term bonds. But short-term debt funds hold bonds with a maturity of 1-2 years and are therefore not very sensitive to interest rate movements. Their earnings are primarily from the accrual of interest on the bonds they hold. Experts believe these funds will do well in the coming months. “Even though we may see one or two more rate cuts, we expect short-term bonds to outperform in the coming months,” R. Sivakumar, Head of Fixed Income at Axis Mutual Fund. In fact, smart money has been flowing into this category for some years now. “The AUM of short-term debt funds has shot up in the past one year. High net worth investors are using short-term debt funds as a tax efficient replacement of fixed deposit,” reveals Kalpen Parekh, CEO, IDFC Mutual Fund.

Best mutual funds for all your different financial goals

Income funds, on the other hand, have a slightly longer maturity profile of 4-5 years. These funds will do well if interest rates are cut further, though experts are divided on whether the RBI will cut rates. If rates are not cut, income funds will give tepid returns. Even so, they are likely to give better post-tax returns in the 30% tax bracket. However, they may suffer some hiccups in the near term because bond yields are close to 7% now. Historically, long-term debt funds have not done too well when bond yields are so low. Go for them only if you intend to remain invested for at least 4-5 years.

When investing in a debt fund, do note that there is a small exit load (0.25-0.5%) payable if you withdraw before a minimum period. This minimum period is usually 6-12 months but can extend to 12-18 months in some cases. SIP investors should note that each monthly instalment is treated as a separate investment. Let’s assume that a fund charges exit load if investments are withdrawn before 6 months. If one starts a 12-month SIP in September 2016 and withdraws the entire amount in September 2017, only the first six SIPs will escape the exit load.

Also Read : ​ The best 5 mutual funds for tax saving

Best mutual funds for medium-term goals: Funds that give best of both worlds
Balanced schemes invest in a healthy mix of equities and debt. While the equity portion boosts returns during bull runs, the debt portion acts as a cushion when markets decline.

What the investor wants
*Moderate risk to capital
*Higher returns than debt
*Flexibility of withdrawal
*Favourable tax treatment

Investors saving for goals that are 4-6 years away are advised to go for balanced funds. These funds invest in a mix of equities and debt, giving the investor the best of both worlds. The fund gains from a healthy dose of equities but the debt portion fortifies it against any downturn. They are suitable for a medium-term horizon. Mumbai-based Koyel Ghosh has been investing in a balanced scheme for the past two years for funding her entrepreneurial dream. She will need the money in about 2-3 years from now.

Balanced funds are of two types. Equity-oriented have a larger portion of their corpus (at least 65%) invested in stocks and qualify for the same tax treatment as equity funds. This means any gains are tax-free if the investment is held for more than one year. These schemes are more volatile due to the higher allocation to stocks.

On the other hand, debt-oriented balanced funds are less volatile and suit those with a lower risk appetite. However, the price of this relative safety is that they offer lower returns and the gains are not eligible for tax exemption. If the investment is held for less than three years, the gains will be added to your income and taxed at the normal rate. The tax is lower if the holding period exceeds three years. The gains are then taxed at 20% after indexation benefit, which can significantly reduce the tax.

Also Read: Best Mutual funds for regular income

Balanced funds have done very well in recent months because both the equity and debt markets have rallied in tandem. But this performance might not sustain, so investors should tone down their expectations. Also, investors might note that the one-year returns of debt-oriented balanced funds are more than those from equity-oriented schemes. But this changes when we look at the medium- and long-term returns. The five-year returns of the top five equity-oriented balanced funds are significantly higher than those of debt-oriented balanced schemes. This statistic should be kept in mind if the investor plans to remain invested for 4-6 years.

Beware of dividends
Balanced funds have attracted huge inflows in recent months, but some of this is for the wrong reasons. Some fund houses are pushing balanced schemes that offer a monthly dividend. This might sound attractive because dividends are tax-free, but in reality this is your money coming back to you. Unlike the dividend of a stock, the NAV of the fund reduces to the extent of the dividend paid out.

Best mutual funds for all your different financial goals

Also, experts view this as an unhealthy practice and point out that the dividend payout might not be sustainable. “The dividend is not guaranteed, and the fund is under no obligation to continue paying a dividend,” points out Amol Joshi, Founder, PlanRupee Investment Services. “If the market declines, the chances of dividend payout and the quantum of dividend will be lower.”

Even so, several fund houses are using this gimmick to attract investors. In some cases, fund houses have even told distributors to alert clients about future dividend announcements and reel them in. This is also an unhealthy practice aimed at garnering AUM by mutual funds.

Best mutual funds for long-term goals: Invest in these equity funds to build wealth
Choose from a wide range of equity funds to invest for goals over seven years away.

What the investor wants
*Good returns on investment
*Reasonable level of risk
*Favourable tax treatment
*Ease of investing, withdrawal

Equity funds should be the vehicle of choice when investing for longterm goals such as your child’s education or your retirement. Diversified equity funds have created enormous wealth for investors in the past 10-15 years. But choosing the right funds monitoring their progress is critical. In the past, many good performing funds have lost their aura and given pathetic returns.

There is a wide choice before investors. Diversified equity funds are divided into four major categories. There are large-cap funds which invest primarily in large-cap stocks. These suit investors looking for stable returns. In the past 10 years, the large-cap category has beaten the Nifty by a thin margin of 78 basis points (100 basis points are equal to one percentage point). The funds in our list have outperformed the Nifty by an average 445 basis points.

Best mutual funds for all your different financial goals

Then there are mid-cap funds which carry higher risk but can also be very rewarding in the long term. The risk quotient rises significantly in small-cap funds, but so do the returns. The top small-cap funds have generated over 40% annualised returns in the past three years. Investors should ideally go for the multi-cap funds that are not confined to any segment and invest across market capitalisations. These go-anywhere funds have been the best performers in the long run. Hyderabad-based Harsh Sharma invests Rs 12,000 a month in a mix of equity, debt and gold funds for very longterm goals that include his newborn child’s education and marriage and his own retirement
Why invest in mutual funds?
Many investors believe they can do better than mutual funds. They believe they can pick multibagger stocks and earn higher returns than a diversified basket of stocks. But picking stocks is not easy, especially when it comes to small- and mid-caps. A study by brokerage firm Motilal Oswal shows that between 2010 and 2015, only 24 of the 200 mid-cap stocks clocked 33% CAGR to become mega-caps. Another 88 grew at a compounded rate of 9% and stayed in the same segment, while another 88 destroyed wealth and moved into the mini-cap segment

Also Read: What are your chances of picking a multibagger stock? Find out

However, many Indian investors still think they can pick stocks better than professional fund managers. “Individuals hold 22% of the total market capitalisation through direct stocks investments and only 4.5% through equity mutual funds,” points out Sanjiv Singhal, Founder and COO of Scripbox.

Also Read: Why mutual funds are better than stocks

Mumbai-based marketing manager Chintak Dalal is a savvy investor who combines his knowledge of stocks with pragmatism. Dalal invests in large-caps stocks directly but relies on mutual funds to invest in small caps. He holds blue-chip stocks such as L&T, HDFC Bank and ITC in his portfolio but has also invested in small-cap funds such as ICICI Pru Discovery Fund and Franklin India Smaller Companies Fund. Both funds have delivered good returns for him. “If you do not have knowledge but want to invest in small- and midcaps, it is best to invest through a mutual fund,” he says
As we have often said, the SIP mode is the best way to invest in equity mutual funds. But this does not mean you stop monitoring your investments. “SIPs are like the auto cruise function in a car. You can relax but still need to watch out for any pothole or sharp turn in the road,” says Nilesh Shah, MD and CEO, Kotak Mutual Fund.