Equity is one of the best investments but it requires fairly large corpus, deep market knowledge and fairly regular monitoring. Mutual funds provide the right opportunity to the millions of investors - who lack money, expertise and/or time - to profit from the equity markets.

Mutual funds are supposed to make life simple! However, the story on the ground is somewhat different.

The number of Asset Management Companies has already crossed 30 and the number is growing. HDFC [Get Quote], Birla, Reliance [Get Quote], Franklin, Principal, Sundaram, LIC [Get Quote], Tata, SBI [Get Quote], UTI, ICICI [Get Quote] Pru, Kotak, DSPML, etc. have been around for quite some time now.

But the tribe is growing with new entrants like HSBC, ABN Amro, Fidelity, Quantum, JM Morgan, AIG, etc. joining the party. While this competition is good as it allows better products & services to be offered, it becomes difficult for an ordinary investor to decide where to go.

Then comes the bewildering mix of funds - short term debt funds, long term debt funds, short term floating rate funds, long term floating rate funds, gilt funds, index funds, tax-saving funds, diversified equity funds, growth funds, dividend yield funds, mid-cap funds, sector-specific funds, close-ended/open-ended funds, etc. not to mention specialty funds like derivative funds, gold funds etc.

Many funds have similar names, which makes it difficult to distinguish between them. Many funds have exotic names. Again, all this variety is good, but it leaves a lay-investor totally foxed.

That's not the end of the story. Having chosen an AMC and a particular fund, you are again caught in a quandary, when you sit down to fill-up the form. Should you opt for growth or dividend? If dividend, then whether payout or reinvestment.

Well, here is a simple 4-point formula to help invest at least a large part of your corpus without many hassles.

Step 1:  Analyse yourself
The most basic rule of any investing is that you must invest keeping in mind your financial profile.

Each one of us has a unique financial profile. Accordingly our investment pattern will also be unique. Hence, we must never invest based on where others are investing.

Therefore, as the 1st step you need to design your investment plan taking into account your financial objectives/needs; the time period you can remain invested; and how much risk you can take with your money.

Step 2: Choose the type of fund
Having defined your investment needs, risk appetite and time horizon, decide how much money will go to which type of fund. As mentioned earlier, there are a wide variety of funds. But broadly speaking you can use the following simple strategy :

Short-term money: The money which you may need within 6 months should go to liquid or short-term floating rate funds.

Medium term money: The money which you need within 1-3 years should go to MIPs (which invest about 10-20 per cent in equity) and balanced funds (which invest about 65-70 per cent in equity). Or you can buy a suitable mix of 100 per cent equity funds and fixed maturity plans/debt funds.

Long term money: The money which you don't need for at least 3-5 years should be put in large-cap/diversified/index funds (about 50-60 per cent), mid/small-caps (about 25-35 per cent) and sector funds (10-15 per cent). You can skip sector funds if your risk appetite is not high.

Step 3: Choose the specific funds
Top performers keep changing from year to year. It is impossible for anyone to predict which will be the top performer next year. Having said that, there are funds, which have consistently delivered above average returns. This is the set of funds, which should be your target.

You have, in step 2, already shortlisted the 'type' of funds you should invest in. Now choose the top 5-7 funds amongst each particular type.

Just make sure that you are suitably diversified across fund houses too, by ensuring that you don't choose too many funds from the same AMC.

Step 4:  Which option is better
The basic returns from the fund will be same irrespective of the option you choose. However, the post-tax returns can be different. To keep things simple, just remember three things

Whatever be the fund, just opt for Growth Option if your holding period is more than one year.

If you plan to invest for less than 1-year in an equity fund (though this is not recommended), opt for Dividend Reinvestment.

If you plan to invest for less than 1-year in a debt fund, opt for Dividend Reinvestment if you are in the higher tax brackets. 

I am not talking about Dividend Payout here because in most cases you don't depend on dividends to take care of your daily needs. Money coming in through the dividend is just a psychological comfort.

Follow this 4-step process and you will be able to suitably deploy your money in the 'right' funds and avoid getting into any 'wrong' ones. Note that here 'right or wrong' doesn't necessarily mean that the funds are 'good or bad', but only whether they match your profile or not. This will help you to achieve your financial objectives safely and surely.

The author is an investment advisor and promoter of wealtharchitects.in. He can be reached at sanjay.matai@moneycontrol.com.

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