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Take a horses-for-courses approach

The key principle to follow while building your portfolio is to have a separate portfolio for each one of your goals

Constructing your mutual fund portfolio is an important issue. In fact, for most investors, it is possibly the most important thing they could understand about investing. Our cover story lays down the principles and a road map for constructing a portfolio. It tells you what kind of funds should be there and how to arrive upon the right mix of funds that is most suited to your approach to investing.

Interestingly, there is a stage before this that all investors must go through in order to understand the logic of portfolios. And that stage is to understand what a portfolio is. A portfolio is actually a leather bag, a type of briefcase. No, seriously. The original meaning of the word is simply a bag designed to carry documents in. It became associated with investments because in the early 20th century, stockbrokers would keep each client's share certificates in a separate portfolio. From there, the word gradually came to mean any kind of collection of documents. In finance, it specifically means the investments held by an investor.

However, in personal finance the word's meaning has evolved a great deal. At Value Research, we no longer like to use the word to just refer to a collection of all of someone's investments. A portfolio is a lot more than a collection. For individuals, the best way to plan their investments is to have a separate portfolio for each financial goal. As you'll learn from our cover story, different mixes lead to different risk levels and different gain expectations. Most people find it difficult to match these to what they want. If you're asked, “What is your risk level?”, you'll probably give an answer of some sort but it will just be a gut feel thing.

However, if you think of specific financial targets and think of the money needed for them, then you will be able to answer questions about risk and returns very precisely. For example, you'll need money for your daughter's higher education after three years. You'd like to buy a house at least ten years before retirement. You'd like to go on a vacation to Europe after two years. You'd like Rs.2 lakh to always be available for emergencies.

Each of these goals is very precise. The risk you can take with it, as well as the amount of money needed can be quantified quite precisely. Therefore, it is relatively easy to decide what kind investments should be made for each of them. In the Value Research way of thinking, there is no concept of an individual's portfolio. Instead each individual must have many portfolios, one for each financial goal. Only then can you tune each portfolio's level of conservativeness or aggressiveness to the right level.

The other thing that I hope this cover story will bring forth is that a portfolio is not simply a collection. It has different parts that fit together in specific roles and complement each other. There could be three funds that provide gains and two stability. In hindsight, it'll later appear that you could have stuck with one or the other but both types played a role.

And those are the big takeaways that you should have as a reader of this magazine. Each portfolio plays a role and inside it, each investment plays a role. As the investor, you need to be clear about exactly what that role is, instead of just hoping for the best.