5 Steps to Build Financial Foundation with Mutual Fund

Published On: 27-Aug-2020

A meticulous plan is vital for achieving a financial goal. At the same time, it is equally crucial for the investors to choose the right investment option amongst a wide spectrum of investment products available. 

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In such a scenario, mutual funds may provide a solid foundation as it offers professional fund management to the investors and further equips them with the flexibility across different asset classes and risk profiles. This helps investors align their investments with their financial plans, as different time horizons may call for change in investment strategies. 

For example, if one wishes to invest in the emergency fund corpus in mutual funds, the investment's stability is crucial as the funds may be required to be withdrawn at any point in time. In such a situation, equity funds, being volatile over the short-term, may not be suitable. 

Instead, the investors may opt for overnight funds and liquid funds, as such funds typically carry insignificant interest rate risk and credit risk. Similarly, the role of mutual funds in financial management cannot be ignored. One can use mutual funds to systematically manage the investment portfolio, be it investment through Systematic Investment Plans (SIPs), periodic redemption through Systematic Withdrawal Plans (SWPs), etc. 

Here are five steps to building a strong financial foundation through mutual funds:

Setting the financial goals

Unless one has a plan to achieve his/ her aspirations, it just remains a wish. However, as one lists down such ambitions and sets a time horizon to achieve such aspirations, they take the shape of a financial goal. It is often said, "if you do not know your destination, any road will take you there." 

Setting financial goals aims to spell out the destinations within the investment journey. To initiate financial planning, one must define the short-term and long-term financial goals on a realistic basis and quantify such goals. 

Choosing an Optimal Asset Allocation Strategy

Asset allocation refers to the proportion of different asset classes within the investment portfolio. While equity markets may be volatile over short-term, but it has been wealth creators over the long term. Similarly, debt may provide stability to the portfolio, but the return expectations must also stay reasonable. 

There is no single right answer for the optimal asset allocation strategy, and the same depends on the investor's risk appetite and the investment horizon. For example, an investor may prefer to have a higher equity allocation towards long term goals, while may prefer to stay conservative with relatively safe debt funds for short term goals. 

Consistent Savings

Once the financial plan has been chalked out, it must be executed systematically through consistent savings. SIP is a process for a disciplined investment of a certain on a pre-decided date in a specific mutual fund scheme, regularly over a period of time. One can register a SIP to make regular investments in specific mutual fund schemes, wherein the amount is deducted automatically from the bank account and invested in mutual funds. 

Such consistent investments also tend to add a sense of financial discipline in investment plans. The investments continue to be made irrespective of market direction, accumulating the desired amounts over the specified time horizon. 

Portfolio Review

One must also regularly review the investment portfolio, objectively track the progress towards the financial goals, and identify underperforming schemes, which may be replaced. This helps the investors keep the portfolio healthy and help it stay relevant for the specified financial goals. 

Portfolio Rebalancing

While an investment strategy may consider equity funds for long term financial goals, the portfolio risk must be moderated suitably, as the goals are within sight. For example, one must systematically reduce the portfolio risk in the retirement corpus as one grows older, as the risk appetite tends to lower with age. It can be done through the Systematic Transfer Plan (STP) to switch investments between different mutual fund schemes. 

With the above steps, one can aim for a strong foundation for financial goals.