Managing finances through Mutual Funds: How to choose funds to fulfill different needs?

Mutual Fund (MF) is not all about equities and stock market risks. There are different categories of funds depending on investments made in equities, debts and money market instruments. Depending on your needs and risk appetite, you may choose a fund that will suit you.

Depending on financial needs and goals you may broadly divide your finances in four categories – emergency fund, short-term funds, medium-term funds and long-term funds. If you want, you may manage all such funds through MF schemes.

Emergency Fund

The money that you would need immediately during an emergency should be kept in an emergency fund. Although it can’t be predicted how much money one may need in case of an unforeseen eventuality, it’s said that a salaried person should keep at least six month’s salary in such a fund.

Apart from liquid cash and savings bank accounts, you may use overnight funds and/or liquid funds to park your emergency fund. As such funds invest in debt instruments having overnight or very short maturity periods, the capital invested generally remains stable.

While the returns are very low, such funds offer excellent liquidity. You may put in a redemption request even on Saturdays and Sundays, and the redemption amount would be credited in your bank account the very next day, if the request is made before the cutoff time.

Short-term Fund

The money needed in short notice of six months to two years is kept in a short-term fund. For example, if a person has taken a loan for building his/her house and payments are to be made in phases within the next 24 months as per the progress of construction, such money may be kept in a short-term fund.

As you can’t wait till recovery in case of reduction in capital invested due to market volatility, you should avoid equity exposure and invest in funds like short-term debt funds and dynamic bond funds that offer low but stable returns.

Medium-term Fund

The money needed in the next 3-4 years may be kept in medium-term funds. For example, if you have accumulated the money needed to meet a financial goal 3-4 years away through equity investments and want to reduce market risks, you may shift the money in a medium-term fund.

In such a case, you need to safeguard your capital and would also need to get higher return to beat inflation in the next 3-4 years.

As pure debt funds may not be able to beat inflation, you may reduce the market exposure from 60-100 per cent to 20-25 per cent by shifting the rest of the money in debt funds. Otherwise, you may shift the money from equity funds to conservative hybrid funds and leave the portfolio management to professional fund managers.

Long-term Fund

The money that is not needed in short and medium term and may be spared for long duration or to meet long-term financial goals, may be put in long-term funds. For example, money needed for a child’s education after 10 years or to accumulate retirement corpus to be used after 20 years may be transferred in such a fund.

As the investment aim for a long-term fund is to beat inflation in the long run by getting superior return – in the absence of short and medium term obligations – you may invest in equities. The quantum of equity exposure will depend on the need to take risks to meet the long-term financial goals and on your capacity to take risks – that is your risk appetite.

Even in the equity segment, you will get the option to invest in medium-risk aggressive hybrid funds to very high risk short-term funds. Higher the risks, higher will be the prospect of generating superior long-term returns.

However, before investing in equity-oriented MF schemes, you should chalk out your financial plan well and enter the markets with a vision to achieve your long-term financial goals. Otherwise, if you enter the equity segment just to get higher returns, you may leave during a market downturn after seeing the returns in negative.

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