A starter pack for mutual fund investors | Value Research Some types of mutual funds are specially suited for investors who are starting off, or who want something simple

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A starter pack for mutual fund investors

Some types of mutual funds are specially suited for investors who are starting off, or who want something simple


Even if you can afford a fancy car as your first one, it probably makes sense to buy a slightly old second-hand one as your first car. For all kinds of reasons that are self-evident to any sensible person, a second-hand car makes a good 'starter car'. On Wikipedia, you can also find information about a peculiarly American concept called 'starter marriage' but we won't go into that.

In a somewhat similar (similar to cars, not marriages) fashion, there are also what one could call 'starter funds'. These are categories of mutual funds that, besides their simple investment characteristics, are especially suitable for investors who are just dipping their toes into mutual fund investing. Moreover, starter funds are actually not just starter funds, but simple funds. That is, they are funds that can serve the entire investment purpose of savers who like to keep things simple and do not have the time or the inclination to spend too much time studying investments.

The first type of mutual fund that serves as a good starter fund is tax-saving funds. Tax-savers' utility as starters comes because of their legal status as tax-savers, as well as their three-year lock-in period. Oftentimes, beginner equity investors are tempted to pull out their investments when they hit their first period of volatility or declines. However, in tax-saving funds, because of the lock-in, they end up getting good returns. Three years is almost always a long enough period for the long-term returns of equity to do their magic. By the time the lock-in ends, the newbie is convinced about the value of patient investments in equity-based funds.

After tax-savers, the first real category of starter funds, as well as simple funds, is hybrid funds, or as they are more commonly known, balanced funds. The role is simple - investors need a set of characteristics, chief among them being a spread of assets at different points on the risk-return spectrum, asset allocation between them, and asset rebalancing on some defined basis when the asset allocation gets out of whack.

When equity is growing faster than fixed income - which is what you would expect most of the time - you would periodically sell some equity investments and invest the money in fixed income so that the balance would be restored. When equity starts lagging, you periodically sell some of your fixed income and move it into equity. This implements beautifully, the basic idea of booking profits and investing in the beaten-down asset. Inevitably, things revert to a mean, and that means that when equity starts lagging, you have taken out some of your profits into a safe asset, reducing the volatility that will panic a new or even an old investor.

You can do all this manually, so to speak. You can choose a set of debt funds, a set of equity funds and use the tools on Value Research Online to monitor and correct your allocation. Or, if you are just starting off, you could try out a type of fund that does it all in one package. This is low-effort, convenient as well as tax-efficient.

Why does this approach work? The two types of financial assets - equity and debt - are not just different, but complementary. There are two major ways that an investment can make money. One, by lending money to someone who pays interest on it, be it a business or a government. And two, by becoming a part-owner of a business, as in having a share in it. The characteristics of the two are such that combining them is the best approach.

Under SEBI's formal codification of different categories of funds, we now have several categories of hybrid funds that can fit different needs of asset allocation. They range from the very conservative, which are essentially fixed income funds with a light garnish of equity, to the very opposite. As such, any investor can find something that is perfectly suitable for their needs. So the best option would be if one could just pick one or two mutual funds and start SIPs, and the funds themselves would do the balancing, which are hybrid funds.

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