Risk management is crucial when you invest your hard-earned money in any of the investment avenues available in the market. When managing investment risk, you should know your actual risk tolerance, your returns expectations that can help fulfil your financial goals on time and whether the risk in your investments justifies the returns they offer.
Investment diversification can be an extremely useful tool to manage portfolio risk, especially when you invest in market-linked products like mutual funds. However, many investors wrongly believe that diversification is nothing but investing in multiple instruments without putting much thought and they end up investing in too many products and schemes. Investing in too many instruments is what is called over-diversification, which could not just make it difficult to manage all the investments but also suppress the portfolio’s overall return-generating potential.
Now, you might be wondering what would be your ideal diversification level and how can you ensure an adequate level of diversification when investing in mutual funds? I’ve discussed a few tips to build an optimally diversified mutual fund portfolio which you’re likely to find useful.
1.Try to maintain the correct balance when allocating fund in different schemes
Diversification requirements may vary from investor to investor depending on their age, risk-taking ability and returns expectations. So, a young investor may require diversification with greater exposure to equity schemes whereas an investor close to retirement may require greater exposure to debt schemes. Exposure to a particular asset class may be high depending on the age of the investor, but within that asset class, the fund should be adequately distributed to different schemes. Let’s suppose you are a young investor with 80% of your portfolio invested in equity schemes and 20% into debt. Now, out of 80% in equity schemes, the fund should ideally be allocated into different equity mutual funds covering small, mid, and large-cap funds as per your return expectations instead of having complete fund allocation into a single fund. The proportion of fund allocation to different asset classes should gradually change with change in the investor’s age and risk appetite.
2.Ensure variation in stock holdings
While diversifying your portfolio, you should also closely look at the stock holdings of your chosen mutual fund schemes. You may want to avoid two similar schemes if their stock holding pattern is the same or identical. The same stock holdings in multiple schemes can spoil your diversification plans as such schemes will result in the same reaction whenever the market is volatile. Investing in schemes with dissimilar stock holdings can allow you better diversification with low portfolio overlap and improve the risk-reward ratio too.
3.Choose different AMCs
Let’s suppose you invest all your money in the mutual fund schemes with the same asset management company and the fund manager. In that case, your investment portfolio’s risk-reward ratio may flatten because every time the fund manager’s approach to a particular situation would be the same. On the other hand, if you invest in mutual funds through different AMCs and different fund managers, it might allow you to better average out their performance when the market turns volatile.
4. Investments should be diversified across different time horizons
Your investments should also be diversified across different schemes and with different time horizons to achieve a greater diversification level. The risk levels usually change in the short and long-term. When you invest in two schemes with different time horizons, it helps to average out the risk more efficiently.
5.Diversify across different underlying benchmarks
Suppose you invest all your money in mutual fund schemes which have the same underlying benchmark. In that case, there are chances that their performance will be similar to each other as the risk associated with their benchmark would be the same. Instead, if you invest in different mutual fund schemes with different underlying benchmarks like CNX 50, BSE 100, etc., the risk associated with such benchmarks will vary and your investment portfolio will get diversified in a better way. In conclusion, diversification is not a one-time practice but a constant process that investors should follow. Sometimes portfolios get skewed towards a particular asset class due to market volatility; therefore, the investor needs to rebalance the portfolio from time to time, and while doing that, it is crucial to diversify the investment properly. Investors would be well-advised to seek assistance from a certified investment advisor if they are unable to optimally diversify their portfolios on their own.
Investment diversification can be an extremely useful tool to manage portfolio risk, especially when you invest in market-linked products like mutual funds. However, many investors wrongly believe that diversification is nothing but investing in multiple instruments without putting much thought and they end up investing in too many products and schemes. Investing in too many instruments is what is called over-diversification, which could not just make it difficult to manage all the investments but also suppress the portfolio’s overall return-generating potential.
Now, you might be wondering what would be your ideal diversification level and how can you ensure an adequate level of diversification when investing in mutual funds? I’ve discussed a few tips to build an optimally diversified mutual fund portfolio which you’re likely to find useful.
1.Try to maintain the correct balance when allocating fund in different schemes
Diversification requirements may vary from investor to investor depending on their age, risk-taking ability and returns expectations. So, a young investor may require diversification with greater exposure to equity schemes whereas an investor close to retirement may require greater exposure to debt schemes. Exposure to a particular asset class may be high depending on the age of the investor, but within that asset class, the fund should be adequately distributed to different schemes. Let’s suppose you are a young investor with 80% of your portfolio invested in equity schemes and 20% into debt. Now, out of 80% in equity schemes, the fund should ideally be allocated into different equity mutual funds covering small, mid, and large-cap funds as per your return expectations instead of having complete fund allocation into a single fund. The proportion of fund allocation to different asset classes should gradually change with change in the investor’s age and risk appetite.
2.Ensure variation in stock holdings
While diversifying your portfolio, you should also closely look at the stock holdings of your chosen mutual fund schemes. You may want to avoid two similar schemes if their stock holding pattern is the same or identical. The same stock holdings in multiple schemes can spoil your diversification plans as such schemes will result in the same reaction whenever the market is volatile. Investing in schemes with dissimilar stock holdings can allow you better diversification with low portfolio overlap and improve the risk-reward ratio too.
3.Choose different AMCs
Let’s suppose you invest all your money in the mutual fund schemes with the same asset management company and the fund manager. In that case, your investment portfolio’s risk-reward ratio may flatten because every time the fund manager’s approach to a particular situation would be the same. On the other hand, if you invest in mutual funds through different AMCs and different fund managers, it might allow you to better average out their performance when the market turns volatile.
4. Investments should be diversified across different time horizons
Your investments should also be diversified across different schemes and with different time horizons to achieve a greater diversification level. The risk levels usually change in the short and long-term. When you invest in two schemes with different time horizons, it helps to average out the risk more efficiently.
5.Diversify across different underlying benchmarks
Suppose you invest all your money in mutual fund schemes which have the same underlying benchmark. In that case, there are chances that their performance will be similar to each other as the risk associated with their benchmark would be the same. Instead, if you invest in different mutual fund schemes with different underlying benchmarks like CNX 50, BSE 100, etc., the risk associated with such benchmarks will vary and your investment portfolio will get diversified in a better way. In conclusion, diversification is not a one-time practice but a constant process that investors should follow. Sometimes portfolios get skewed towards a particular asset class due to market volatility; therefore, the investor needs to rebalance the portfolio from time to time, and while doing that, it is crucial to diversify the investment properly. Investors would be well-advised to seek assistance from a certified investment advisor if they are unable to optimally diversify their portfolios on their own.
It is mandatory to file your income tax return (ITR) for various reasons, especially if you have a tax refund to claim. Once you file your ITR, the income tax department does the assessment and refund, if any, gets credited directly into your pre-validated bank account.
When does a tax refund become due and how do I claim it?
According to income tax rules, tax needs to be deducted at sources of income at prescribed rates, by the payer. Sources of income can be: salary, interest, commission, rent, brokerage, professional fees, royalty, and others. So, in the case of salary, the rate of tax deducted at source (TDS) should be in line with the income tax slab applicable to the individual. Once TDS is deducted, the same needs to be remitted into the account of the central government within a stipulated time. However, often, recipients of income do not make proper declaration of expenses and investments that can bring down their taxable income. As a result, excess TDS is deducted. Such additional tax paid can be claimed back as refunds, but only if you file your tax return. If you don't file your ITR, you can't claim a tax refund.
Do I earn any interest on the income tax refund due?
Where the income tax refund amount exceeds 10 percent of the total income tax paid, the government pays interest on the due amount under Section 244A of the Income Tax Act, 1961. Under this section, interest at the rate of 0.5 percent a month has to be paid on the refund amount, starting from the first day of the assessment year till the date of grant of refund.
How can I track the status of my income tax refund?
Once you file your ITR and claim a tax refund, you can check the status of your refund online through www.incometaxindia.gov.in or www.tin-nsdl.com. Log on to any of these two websites and click on “Status of Tax Refunds" tab, enter your PAN and the assessment year (AY) for which your refund is pending. If the refund has already been processed by the department, you will get a message mentioning the mode of payment, a reference number, status and date of refund. If the refund has not been processed or has been declined, the message will say so.
What are the possible reasons for the delay in getting a tax refund?
There could be various reasons behind delay or decline of income tax refund by the tax department. The most common reason behind delay is usually incorrect bank account details put in the ITR form by assessees. While filing the ITR, bank details, including the name of the bank, account number, and the 11-digit IFS Code of the bank or details of international bank account number (IBAN) in case you have a foreign bank account, need to be mentioned correctly.
Also, ensure that the bank account selected to get the refund is pre-validated with the e-filing account and also linked with your PAN.
The other common reason for delay or not getting the refund is that there is a mistake in calculating the refund.
Can I rectify the mistakes before placing a request for re-issue of income tax refunds?
Don’t worry if the status report makes you realize that you have made a mistake in your bank account details while filing your ITR, because you will be allowed to make corrections in such cases. For this purpose, log in to the e-filing portal (www.incometaxindiaefiling.gov.in), go to “My Account" and then click on “Refund re-issue request." Follow the steps and enter the correct details of the bank account in which you want your income tax refunds to get credited, and submit the request. If your details are properly filled in the ITR, then you can expect to receive the refund within few days.
When does a tax refund become due and how do I claim it?
According to income tax rules, tax needs to be deducted at sources of income at prescribed rates, by the payer. Sources of income can be: salary, interest, commission, rent, brokerage, professional fees, royalty, and others. So, in the case of salary, the rate of tax deducted at source (TDS) should be in line with the income tax slab applicable to the individual. Once TDS is deducted, the same needs to be remitted into the account of the central government within a stipulated time. However, often, recipients of income do not make proper declaration of expenses and investments that can bring down their taxable income. As a result, excess TDS is deducted. Such additional tax paid can be claimed back as refunds, but only if you file your tax return. If you don't file your ITR, you can't claim a tax refund.
Do I earn any interest on the income tax refund due?
Where the income tax refund amount exceeds 10 percent of the total income tax paid, the government pays interest on the due amount under Section 244A of the Income Tax Act, 1961. Under this section, interest at the rate of 0.5 percent a month has to be paid on the refund amount, starting from the first day of the assessment year till the date of grant of refund.
How can I track the status of my income tax refund?
Once you file your ITR and claim a tax refund, you can check the status of your refund online through www.incometaxindia.gov.in or www.tin-nsdl.com. Log on to any of these two websites and click on “Status of Tax Refunds" tab, enter your PAN and the assessment year (AY) for which your refund is pending. If the refund has already been processed by the department, you will get a message mentioning the mode of payment, a reference number, status and date of refund. If the refund has not been processed or has been declined, the message will say so.
What are the possible reasons for the delay in getting a tax refund?
There could be various reasons behind delay or decline of income tax refund by the tax department. The most common reason behind delay is usually incorrect bank account details put in the ITR form by assessees. While filing the ITR, bank details, including the name of the bank, account number, and the 11-digit IFS Code of the bank or details of international bank account number (IBAN) in case you have a foreign bank account, need to be mentioned correctly.
Also, ensure that the bank account selected to get the refund is pre-validated with the e-filing account and also linked with your PAN.
The other common reason for delay or not getting the refund is that there is a mistake in calculating the refund.
Can I rectify the mistakes before placing a request for re-issue of income tax refunds?
Don’t worry if the status report makes you realize that you have made a mistake in your bank account details while filing your ITR, because you will be allowed to make corrections in such cases. For this purpose, log in to the e-filing portal (www.incometaxindiaefiling.gov.in), go to “My Account" and then click on “Refund re-issue request." Follow the steps and enter the correct details of the bank account in which you want your income tax refunds to get credited, and submit the request. If your details are properly filled in the ITR, then you can expect to receive the refund within few days.
After years of working hard, you may want less to worry about your day-to-day expenses in the later years of your life.
Apart from regular needs, old age has health care expenses as well. It is, therefore, important to plan ahead for ways to generate income in these years.
Depending on your existing savings from years of employment, your needs and risk appetite, there are several options of income sources for your retirement years to choose from. Here are a few.
1. Pension Plans
This income source requires prior planning. These could be useful to those who have smaller "basic pay" element in their salaries as this would mean that their PF (provident fund) contributions over several years of employment will also be small. In such cases, PF accumulation will also not suffice to beat inflation.
Apart from monthly income, pension plans come with death benefits, benefit to spouse after death, etc. However, there are so many pension plans in the market with varied complexities and benefits that it could become confusing to pick the right one.
Some of these also offer tax benefits, especially if it has life-insurance linked to it. It is important to pick the right one that helps you meet your financial needs in your retirement years with stable/guaranteed monthly income.
The choice should not be made on the basis of the tax-saving prospects alone as there may be other costs associated with annuity and other such pension plans.
2. Rental income
If you are far from retirement, investing in a second property for rental income could be a good low-maintenance source of income. In the initial years, revenue from rent could be even used to pay the mortgage for the house/commercial space. In fact, now is a great time to purchase real estate, with low-interest rates on loans and a decline in property prices. But, will have to spend some time on setting up the place.
Eventually, when you retire, you will have paid off the loan and be able to continue earning rent on the property. However, note that such capital assets come with maintenance expenses. There could be a leak, termite issues, etc which needs to be taken care of. You will require to set aside a budget for such unexpected repairs as well as upkeep expenses like painting and plumbing.
3. Five-year tax-saving FDs
With tax benefit under section 80C of the Income Tax Act, these 5-year FDs are available at all banks and post offices. These provide guaranteed interest income with periodic payout option (monthly or quarterly) if a maximum amount of Rs 1.5 lakh is locked for a period of 5 years with the post office or a bank of your choice. While these are safe and offer a guaranteed payout, these may not be your best bet at the moment with a sharp decline in FD interest rates due to COVID-19. You may regret locking your money for a long period of 5 years.
4. Mutual Funds - Monthly Income Plans (MIP)
Mutual Funds helps in diversifying portfolio without you having to select a bunch of stock/debt investment options yourself. Mutual fund houses provide Monthly Income Plans (MIPs) that generate monthly incomes through a mix of debt and equity-based investments. A significant part of the portfolio focuses on interest-bearing assets such as corporate or government bonds and the rest is invested in equity. The low equity exposure in such mutual funds ensures that the monthly returns on the investment are more or less stable. These payouts may be made monthly, quarterly, bi-annually or annually. Note that though these may have low equity exposure, these are still market-linked instruments and could face market-related volatility. The payouts are based on profits and will not always be steady.
5. A part-time job or small business
While most dream of never wanting to work again, some desire to stay active even after they turn 60 years of age. The idea may not be to earn a good income; it could simply be about getting out to go somewhere and be among people for a few hours of the day. Senior citizens could engage themselves by working for NGOs like charity houses, which have relaxations on retirement age, less workload and also pay a decent salary. If you have been postponing a hobby or interest that you can turn into a side business, in your retirement years you have ample amount of time to work on it for additional income.
Conclusion
It is always easier to secure retirement income if you plan ahead of time. You may want to add a good health insurance scheme in your planning to cover unexpected medical expenses. Further, you also need to avail senior citizens cash benefits offered by the central, state as well as local governments.
Apart from regular needs, old age has health care expenses as well. It is, therefore, important to plan ahead for ways to generate income in these years.
Depending on your existing savings from years of employment, your needs and risk appetite, there are several options of income sources for your retirement years to choose from. Here are a few.
1. Pension Plans
This income source requires prior planning. These could be useful to those who have smaller "basic pay" element in their salaries as this would mean that their PF (provident fund) contributions over several years of employment will also be small. In such cases, PF accumulation will also not suffice to beat inflation.
Apart from monthly income, pension plans come with death benefits, benefit to spouse after death, etc. However, there are so many pension plans in the market with varied complexities and benefits that it could become confusing to pick the right one.
Some of these also offer tax benefits, especially if it has life-insurance linked to it. It is important to pick the right one that helps you meet your financial needs in your retirement years with stable/guaranteed monthly income.
The choice should not be made on the basis of the tax-saving prospects alone as there may be other costs associated with annuity and other such pension plans.
2. Rental income
If you are far from retirement, investing in a second property for rental income could be a good low-maintenance source of income. In the initial years, revenue from rent could be even used to pay the mortgage for the house/commercial space. In fact, now is a great time to purchase real estate, with low-interest rates on loans and a decline in property prices. But, will have to spend some time on setting up the place.
Eventually, when you retire, you will have paid off the loan and be able to continue earning rent on the property. However, note that such capital assets come with maintenance expenses. There could be a leak, termite issues, etc which needs to be taken care of. You will require to set aside a budget for such unexpected repairs as well as upkeep expenses like painting and plumbing.
3. Five-year tax-saving FDs
With tax benefit under section 80C of the Income Tax Act, these 5-year FDs are available at all banks and post offices. These provide guaranteed interest income with periodic payout option (monthly or quarterly) if a maximum amount of Rs 1.5 lakh is locked for a period of 5 years with the post office or a bank of your choice. While these are safe and offer a guaranteed payout, these may not be your best bet at the moment with a sharp decline in FD interest rates due to COVID-19. You may regret locking your money for a long period of 5 years.
4. Mutual Funds - Monthly Income Plans (MIP)
Mutual Funds helps in diversifying portfolio without you having to select a bunch of stock/debt investment options yourself. Mutual fund houses provide Monthly Income Plans (MIPs) that generate monthly incomes through a mix of debt and equity-based investments. A significant part of the portfolio focuses on interest-bearing assets such as corporate or government bonds and the rest is invested in equity. The low equity exposure in such mutual funds ensures that the monthly returns on the investment are more or less stable. These payouts may be made monthly, quarterly, bi-annually or annually. Note that though these may have low equity exposure, these are still market-linked instruments and could face market-related volatility. The payouts are based on profits and will not always be steady.
5. A part-time job or small business
While most dream of never wanting to work again, some desire to stay active even after they turn 60 years of age. The idea may not be to earn a good income; it could simply be about getting out to go somewhere and be among people for a few hours of the day. Senior citizens could engage themselves by working for NGOs like charity houses, which have relaxations on retirement age, less workload and also pay a decent salary. If you have been postponing a hobby or interest that you can turn into a side business, in your retirement years you have ample amount of time to work on it for additional income.
Conclusion
It is always easier to secure retirement income if you plan ahead of time. You may want to add a good health insurance scheme in your planning to cover unexpected medical expenses. Further, you also need to avail senior citizens cash benefits offered by the central, state as well as local governments.
As the Sensex has now risen close to 60% since March when it hit the lowest level due to the outbreak of Covid-19 pandemic in the country and the nationwide lockdown, equity investors should look at some profit booking and move money from equities to debt or gold to rebalance the overall portfolio. Equity valuation has become expensive as surplus liquidity in the markets is driving up stock prices without any significant recovery in the real economy. Market volatility, too, remains high and earnings growth has been at low single digits for the last six years.
Asset allocation strategy
Asset allocation is the first step to build one’s long-term portfolio. It should factor in the investor’s age, risk appetite, and financial goals such as buying a house, higher education of children or retirement. Investing over the long term and rebalancing the portfolio periodically are the most important factors that an investor must keep in mind to create wealth. Adhering to a proper asset allocation strategy—investing in equities, debt, gold, real estate—and rebalancing the portfolio will help an investor to ride out the market volatility and not panic when there is a market correction.
Asset allocation is a must in the wealth creation journey and it is unique for each individual. “An individual should set up the asset allocation framework based on the goal, risk appetite and risk tolerance. He has to ensure that at least 36 months of liquidity is in place, as black swan events can create uncertainty, out of the blue.
Profit booking in equity
Typically, when there’s a correction in the markets, individual investors panic and sell their equity-related investments anticipating a further fall. Some even liquidate all their equity portfolio and money to fixed income instruments such as bonds, small savings, bank deposits. Investors should not rush to invest in equities now because the markets are rising. Instead, they should revert to their asset allocation strategy and buy in dips.
Mutual fund investors should continue their systematic investment plans (SIPs) to take advantage of the cost averaging. In fact, while there is a moderation in the inflows through SIPs, the share of SIPs in the total assets under management in September is at 13%, a record high. Also, during the last four years, the number of SIP accounts increased 30% to 3.3 crore.
Investors must keep in mind the tax impact on long-term capital gains and short-term capital gains before doing any profit booking. Long-term capital gains accrued from selling equity-related investments after one year of holding are taxed at 10% for redemption over Rs 1 lakh in a financial year. Short-term capital gains (holding below one year) are taxed at 15%. Analysts say if an investor is looking at profit booking, he should redeem those units which have completed one year. Rebalancing will also help an investor to remove low quality stocks and/or underperforming schemes from the portfolio.
Increase debt allocation
The profits booked from equity can be invested in fixed income securities and even gold to rebalance the portfolio. If an individual is nearing retirement, the allocation to debt should increase. Investors can look at lower-risk debt categories. Ideally, one should have a certain allocation to debt mutual funds and choosing the right type of debt funds is important. Analysts suggest corporate bond funds and banking and PSU debt funds are ideal investments in the current environment.
Before investing in debt funds, analyse the credit risks and interest rate risks. Analyse the fund house’s investment portfolio—whether the bonds are from well-known companies—and check whether the fund manager is chasing returns by taking higher credit risk. Also look at liquidity risks of the funds and understand how quickly the fund manager can sell the particular paper in case of any downgrade. Corporate bonds of high-rated companies are more liquid than the lower-rated paper.
Asset allocation strategy
Asset allocation is the first step to build one’s long-term portfolio. It should factor in the investor’s age, risk appetite, and financial goals such as buying a house, higher education of children or retirement. Investing over the long term and rebalancing the portfolio periodically are the most important factors that an investor must keep in mind to create wealth. Adhering to a proper asset allocation strategy—investing in equities, debt, gold, real estate—and rebalancing the portfolio will help an investor to ride out the market volatility and not panic when there is a market correction.
Asset allocation is a must in the wealth creation journey and it is unique for each individual. “An individual should set up the asset allocation framework based on the goal, risk appetite and risk tolerance. He has to ensure that at least 36 months of liquidity is in place, as black swan events can create uncertainty, out of the blue.
Profit booking in equity
Typically, when there’s a correction in the markets, individual investors panic and sell their equity-related investments anticipating a further fall. Some even liquidate all their equity portfolio and money to fixed income instruments such as bonds, small savings, bank deposits. Investors should not rush to invest in equities now because the markets are rising. Instead, they should revert to their asset allocation strategy and buy in dips.
Mutual fund investors should continue their systematic investment plans (SIPs) to take advantage of the cost averaging. In fact, while there is a moderation in the inflows through SIPs, the share of SIPs in the total assets under management in September is at 13%, a record high. Also, during the last four years, the number of SIP accounts increased 30% to 3.3 crore.
Investors must keep in mind the tax impact on long-term capital gains and short-term capital gains before doing any profit booking. Long-term capital gains accrued from selling equity-related investments after one year of holding are taxed at 10% for redemption over Rs 1 lakh in a financial year. Short-term capital gains (holding below one year) are taxed at 15%. Analysts say if an investor is looking at profit booking, he should redeem those units which have completed one year. Rebalancing will also help an investor to remove low quality stocks and/or underperforming schemes from the portfolio.
Increase debt allocation
The profits booked from equity can be invested in fixed income securities and even gold to rebalance the portfolio. If an individual is nearing retirement, the allocation to debt should increase. Investors can look at lower-risk debt categories. Ideally, one should have a certain allocation to debt mutual funds and choosing the right type of debt funds is important. Analysts suggest corporate bond funds and banking and PSU debt funds are ideal investments in the current environment.
Before investing in debt funds, analyse the credit risks and interest rate risks. Analyse the fund house’s investment portfolio—whether the bonds are from well-known companies—and check whether the fund manager is chasing returns by taking higher credit risk. Also look at liquidity risks of the funds and understand how quickly the fund manager can sell the particular paper in case of any downgrade. Corporate bonds of high-rated companies are more liquid than the lower-rated paper.