First we should choose the fund houses based on the performance in good times as well as bad times over a period of 5-10 years instead of 1-2 years.
Some recommendations are SBI Magnum, Reliance, Fidelity, HDFC, ICICI etc. Then we should allocate our investible funds for different categories starting first with diversified funds.
1) Diversified funds: are always less risky as they cover multiple growth sectors instead of a particular sector or theme. You can have a long term view of 10-20 years in them. Upto 60% of the total investments can be made in diversified funds.
2) Equity Linked Saving Scheme(ELSS): Only difference from diversifies funds is that they save us tax also and since there is a lock in period of 3 years fund managers have less pressure of redemption. The amount of funds invested in ELSS should be governed by our tax planning needs.
3) Sector funds or thematic funds: are more risky in nature and outlook of the sector should be taken into consideration before investing. Also we should not invest in sector funds at the peak of the sector performance. Upto 30% of the total funds can be invested in sector or thematic funds. Time horizon for investments in such funds should be 3-5 years and they need closer monitoring then diversified funds.
Example: IT funds outperformed all other funds in late 90's but once they crashed in 2000 they lost up to 90% of their value and took next 3-5 years to recover the old highs.
Some sector funds that have given good returns in the past few years are Reliance diversified power fund, Reliance Media and Entertainment fund and ICICI Prudential Infrastructure fund.
4) Contrarian funds: invest in sectors or companies which have good growth potential in future but are currently disliked by the investors due to sentiments, short term difficulties etc.
They should be a part of each investor portfolio and 10-20% of the funds can be allocated to them. Investments should be made with a time horizon of more then 5 years. Investors can continue to hold the fund even when markets peak as by definition contra funds switch to new sectors when a particular sector peaks out.
Example: Magnum Contra fund has given fabulous returns over last few years.
Ø Investments can be divided between large cap funds and mid caps funds based on risk profile and age. A young person with higher risk appetite can go for higher allocation to mid-cap funds.
Ø While investment decisions are better left to the fund manager we need to constantly monitor the fund performance at least once or twice a year but not daily or weekly. If the performance of the fund is consistently poor as compared to other similar funds we can think of switching to other funds(Please note this involves the extra costs of exit load and entry load)
Ø We should not choose an NFO over existing funds just because NAV of Rs 10 is less then an existing fund. Only the % returns should matter rather then NAV of Rs 10 or Rs 100. In fact NFOs have the disadvantage of higher fees and no past performance to prove its credibility.
Ø Instead of replacing our equity portfolio MFs should complement it.
Example: If one has more mid-caps in his equity portfolio then he should go for a MF having large caps exposure. If a particular sector is good but missing in your portfolio then go for that sector fund.
Ø Dividends of mutual funds are not same as a dividend by the company. A company shares its profits by paying dividend while dividend of a MF means they are returning a part of your invested amount back. So opt for a dividend option only if you need regular tax free income (especially old people).