We may use the same funds for different goals (apart from tax-saving or cash management goals) because it is the asset allocation i.e. the split between equity (high returns but volatile) and debt (stable but FD-like returns) every year, that determines the overall risk and return profile of the goal.
For example, for a long term Wealth goal, we can have 100% equity and 0% debt. But for a 5-year goal like House, we may have only 40% equity and 60% debt (and the equity part keeps decreasing with every subsequent year, coming down to 0% in the 5th year).
Within equity, whether it is 100% or 40% of the investment, we must use the equity funds that we believe will give us the best returns, and the same goes for debt.
There are very good reasons to have different asset allocations for different goals, but there is no good reason for us to select different funds for different goals, especially for the same risk-profile. If a fund will give us high returns in one goal, it will give us high returns in another goal as well. It is the asset allocation that should be different for different goals, and not necessarily the individual funds.
Selecting the Best Mutual Funds
There are more than 1500 Equity Mutual Funds and more than 5000 Debt Funds available to an Indian investor. Selecting the best Mutual Funds from such a huge universe is a daunting task and requires a lot of research. We believe that this is one of the areas where we add significant value for our investors.
Essentially, it boils down to using quantitative data and qualitative factors to figure out which funds (and fund managers) have superior investing skill, and which ones merely got lucky. The underlying principle is that skill can be repeated, whereas luck cannot.
We look at historical data – returns, volatility, consistency of outperformance in good and bad economic environments etc. - over the last 7-10 years in order to select the best 3-4 equity and debt funds for our investors. This process is repeated every year, as a result of which old funds are dropped and new funds are brought in.
Setting up a Goal
While setting up a goal, an investor has to choose the:
- Purpose of the goal (Wealth, Children’s Education or Marriage, Vacation, or a big purchase, like a Car or down payment for a House etc)
- Time Horizon for the goal
- Target Amount, and
- Risk Tolerance for that goal
Depending on these inputs, our GoalSenseTM technology calculates an optimum investment plan for her to achieve that goal along with the monthly investment needed. This plan includes a suitable year-by-year asset allocation between equity (high returns but volatile) and debt (stable but FD-like returns), a select list of the best Mutual Funds within equity and debt, and the exact amount to be invested in each of them.
With the click of a button, she can then start investing in that goal plan. Behind the scenes, we do all the hard work of executing the investment plan on her behalf for the entire time horizon, right till the end.
Why we use the same Mutual Funds for different goals
Apart from characteristically different goals like Tax-Saving (where we use special Tax-Saving funds i.e. ELSS) and Cash-Alternatives (either as an emergency fund or for temporary parking of surplus cash, where we use Liquid Funds), almost all other goals use the same select group of Equity and Debt funds for a given risk profile.
While this may sound un-intuitive, it actually makes sense. In order to understand why, let us first understand how goals differ from one another. From a pure investment planning angle, a Wealth-building goal differs from, say, a Child’s Education goal in:
Time Horizon: Wealth is generally a long-term goal, say 20 years, whereas you might need money for your Child’s Education in 5 years.
Pattern of consumption: In case of a Child’s Education, most of the money might be required in one-go or over a couple of years (it is a purchase goal). But in the case of a Wealth goal, there is no such concrete requirement (it is a lifelong goal). The money will be used as and when needed, or it will be left to grow.
Risk Tolerance: You might have a higher risk tolerance for your Wealth goal, while being conservative in your risk tolerance for your Child’s Education goal.
These differences in time horizon, pattern of consumption and risk tolerance between the goals result in different year-by-year asset allocations between equity and debt (Goal Path) for each goal.
For example, for a long term Wealth goal, we can have 100% equity and no debt. But for a 5-year goal like Child‘s Education we may have only 40% equity and 60% debt. With every subsequent year, the equity part keeps decreasing, coming down to 0 in the 5th year. It is this asset allocation and goal path that determines the overall risk and return profile of the goal.
Within Equity, whether it is 100% or 40% of the investment, we must use the equity funds that we believe will give us the best returns. The same holds true for Debt.
There are very good reasons to have different asset allocations and different goal paths for different goals. But there is no good reason to select different mutual funds for different goals, especially for the same risk-profile. If a fund will give us the best returns for one goal, it will give us the best returns for another goal as well. It is the asset allocation that should be different for different goals, and not necessarily the individual funds.