Is it a good idea to invest only in Five or Four Star rated funds for a time period of 3 years in debt and 5 years in diversified equity funds?
Selecting a good fund to invest in is definitely an important first step. And there is no better place to start than the Value Research Fund Rating on valueresearchonline.com. In one go you can get a snapshot on the best performing funds in terms of their historical risk-adjusted returns. Funds, which are rated as Four and Five Stars, have some of the best risk-adjusted returns in their category.
However, ratings are only the starting point. After selecting the funds you want to invest in, you should look for their investment objectives and aims. You should be comfortable with the way a fund generates its returns. Two funds may be rated as Five Star, but one may generate returns through a concentrated portfolio, while the other may be more diversified.
Some funds may move heavily into cash while others may remain fully invested. Similarly, some schemes may invest heavily in mid-caps, while others will stick to large-caps. So, it is not just important that a fund generates high risk-adjusted returns but how does it do it. As ratings are a purely quantitative exercise, they cannot capture these facets of a fund's performance.
You may feel that this calls for quite an effort and you are correct. Choosing good funds requires spending time and effort. Ratings can help, but they cannot take you all the way to your destination.
Once you have selected your funds, do work out an asset allocation-i.e. the amount you will invest in equity and debt. This will depend on the risk you can take and the duration for which you can remain invested. As a general rule, for a period greater than three to five years, equities are suitable, while for smaller time periods, you should opt for debt instruments. Along the way, do rebalance your portfolio at regular intervals so that your ideal allocation is maintained. Happy investing!