Crafting a retirement portfolio with mutual funds

Authored by Nityanand Prabhu, Executive Director and Business Head, LIC Mutual Fund Asset Management Ltd.

The thought of a retirement life always evokes splendid pictures of relaxation, leisurely travel, and spending quality time with loved ones. However, the road to a financially sound retirement life is not always smooth. Planning and systematic investment from an early age is crucial to ensure a regular retirement income, which is essential for a joyful life. Mutual funds (MF) may be a suitable financial instrument, even for late entrants, to craft a retirement portfolio that aligns with one’s goals and risk profile. It would also ensure better liquidity and efficient risk management.

Creating a retirement portfolio through MFs demands a strategic and skilful approach that takes into account one’s financial priorities. Careful selection and diligent management of MF schemes are crucial in attaining these objectives.

Set future goals

The first step is to clearly define the retirement goals. Are you aiming for an early retirement, or do you plan to work well into your 60s? Understanding life objectives will be very crucial in selecting MFs. If one has a longer time horizon, the investor can afford to take on more risk with their investment portfolio. Conversely, if retirement is just around the corner, a more conservative approach is prudent.

Build a diversified portfolio

When it comes to retirement planning, diversification is the key. It will help investors spread risk and reduce exposure to financial market volatility. Mutual funds, which pool money from multiple investors to invest in a diversified portfolio of stocks or bonds, provide the best route to reduce risk and protect savings.

Assess risk tolerance

Before diving into MF selection, it’s paramount to assess the investor’s risk tolerance. This helps determine the right mix of funds for the retirement portfolio. If you’re risk-averse, you may lean towards conservative funds such as bonds or money market funds. Those comfortable with higher risk might opt for equity funds. Balancing risk and return is a key to crafting a portfolio that suits an individual's future goals.

Optimum allocation of assets:

Once you determine the risk tolerance and goals, it’s time to allocate money among different types of MFs. A common rule of thumb is to allocate a portion of your fund to stocks and the rest to bonds. How to divide one’s money between stocks and bonds depends on the investor’s risk profile and investment horizon.

A conservative investor might opt for a 70/30 split between bonds and stocks, while someone with a higher risk appetite could go for a 50/50 or even a 40/60 allocation. One can further diversify by including international funds or sector-specific funds in your portfolio.

Select suitable MF

While selecting mutual funds, consider factors like historical performance, expense ratio (annual fees), and fund manager’s expertise. Look for funds with a track record of consistent returns. Past returns are an important parameter to gauge a scheme’s performance. A low expense ratio is another important factor to be considered in evaluating one’s returns over the long term.

Index funds and exchange-traded funds (ETFs) can be excellent choices for cost-conscious investors as they often have lower annual maintenance fees than actively managed funds. However, the actively managed funds have a higher potential to outperform the benchmark returns with a relatively higher expense ratio.

Monitoring and rebalancing

Monitor the performance of your funds regularly and rebalance the portfolio if necessary. Over a period of time, one’s asset allocation may drift from the desired target due to market volatility. The net asset value (NAV) of a scheme is declared every day and it changes with market fluctuations. The NAV is an indicator that helps investors to track the performance of the scheme. Rebalancing will help an investor to ensure that the portfolio stays aligned with his/her risk profile and retirement goals.

The path to a secure retirement may have its challenges, but with thoughtful planning, mutual funds offer a reliable vehicle to achieve financial freedom in later years. Due to the extensive benefits, it offers and flexibility, Mutual Fund is one of the best financial instruments that help investors to be part of wealth creation that will ensure a smooth retirement.

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