How To Use Mutual Funds For Diversification

In today’s unpredictable financial landscape, diversification isn’t just a buzzword — it’s a necessity. Think of it as spreading your investments across different baskets so that if one falters, the others can still thrive. And one of the best ways to diversify is through mutual funds. But how exactly can you use them to achieve your financial goals?

Let’s break it down, step by step, so you can make informed decisions based on your needs, goals, and risk appetite.

Start with Your Financial Goals

Before choosing any investment, clarity is crucial. Your goals and time horizon will determine the type of mutual funds you should invest in. Ask yourself:

• What am I investing for? Is it retirement, a house, children’s education or to build a capital for a future venture?

• What is my time frame? Short-term (1-3 years), medium-term (3-7 years), or long-term (7+ years)??

• What is my risk tolerance? What level of risk am I comfortable with for potential returns? Am I willing to take on greater volatility for potential higher returns, low volatility or a middle road?

Your goals will define the type of mutual funds you should choose. If you’re unsure, a financial advisor can help you map out your journey.

Use Equity Mutual Funds for Long-Term Growth

If your goal is long-term wealth creation, equity mutual funds can be ideal option. But to reduce risk, diversify within the equity space itself.

A portfolio should always have a core and satellite portion, and you look to add funds in the large-cap space along with other offerings from mid, small cap and thematic offerings to add potential for alpha in your portfolio.

Solution: If you are looking for growth, over a 7–10-year horizon, allocate a portion of your portfolio to large-cap funds, with exposure to other funds for potential alpha depending on the opportunities and fit in your portfolio. A balanced mix will ensure steady growth and help you navigate market movements.

Include Debt Mutual Funds for Stability

Debt mutual funds can be ideal for those who seeking relative stability, especially when you are closer to reaching your financial goals or are conservative. These funds invest in government securities, bonds and other fixed-income securities, offering more predictable or stable returns with lower risk. Moreover, you pay taxes on debt funds only at the time of redemption whereas in case of traditional options you are bound to pay taxes on accrued interest every year.

• For Emergencies: Use Liquid Funds or Money Market Funds for emergencies, or when you need quick access to money with comparatively lower risk in the debt funds space.

• For Longer tenures: Look at other debt funds like corporate bond funds, dynamic bond funds and gilt funds depending on the horizon and risk appetite. These funds have the potential to offer better tax-adjusted returns vis-à-vis traditional offerings.

Solution: Based on your investment horizon choose a debt fund. For very short-term goals or emergencies, allocate funds to liquid funds or money market funds and for longer-term goals, choose a debt fund depending on your risk-appetite and horizon. If you’re nearing a financial milestone, debt funds can work towards protecting your capital and provide fixed income.

Leverage Hybrid Mutual Funds for Balanced Growth

If you aim to benefit from multiple asset classes — equity for growth, debt for relative stability and commodities like gold and silver as a hedge against inflation — you can consider hybrid mutual funds. These funds invest in atleast two asset classes, making them ideal for moderate-risk investors who are looking to diversify their portfolios and make them all-weather funds. There are plenty opportunities like equity hybrid funds (predominantly invest in equity), conservative hybrid funds (predominantly invest in debt), balanced advantage funds (move between equity and debt depending on the market conditions) and multi-asset allocation funds (invest in three or more asset classes to diversify your portfolio).

Solution: Hybrid funds can be used if you’re looking to let the task of asset allocation set by an experienced fund manager without the hassle of tracking multiple asset classes and taxation of moving between them.

Add Gold / Silver Mutual Funds for Protection

Gold & Silver-based mutual funds act as hedge against inflation and during volatile market conditions. In times of uncertainty, having a portion of your portfolio in these commodity-based funds looks promising statement that you’re protected from market swings while benefiting from the flight towards safety / hedge during volatile times.

Solution: Have some allocation, say 5-10% of your portfolio, in these funds to hedge against market risks, especially during times of high inflation or economic instability or choose multi-asset allocation funds which can allocate a portion of the portfolio towards these commodities.

Consider International Mutual Funds for Global Exposure

Want to diversify beyond India? International mutual funds provide access to global markets, allowing you to tap into growth in other economies. This is particularly useful when some sectors or regions outside India are outperforming the domestic market.

Solution: If your goal is long-term diversification and protection against domestic market downturns, allocate a small portion (10-15%) of your portfolio to international mutual funds.

Regularly Review and Rebalance Your Portfolio

Once you’ve diversified, the job isn’t done. Markets fluctuate, and your portfolio will too. Regular reviews are essential to ensure your investments are aligned with your goals.

Solution: Every 6-12 months, check your portfolio. If equity funds have grown too much and become a larger portion than you intended, rebalance by moving some of that money into debt or hybrid funds to maintain your risk profile.

Tailor Your Portfolio to Your Needs

Diversifying through mutual funds is about creating a portfolio that fits your specific financial goals and risk tolerance. Whether you’re looking for growth, stability, or a mix of both, mutual funds provide the flexibility to craft a plan that’s right for you.

Disclaimer

These views alone are not sufficient and should not be used for the development or implementation of an investment strategy. Please consult your investment advisor before making an investment decision.

An Investor Education and Awareness Initiative by SBI Mutual Fund.

Investors should deal only with registered Mutual Funds, details of which can be verified on the SEBI website (https://www.sebi.gov.in) under ‘Intermediaries/Market Infrastructure Institutions’. Please refer to website of mutual funds for process of completing one-time KYC (Know Your Customer) including process for change in address, phone number, bank details etc. Investors may lodge complaints on https://www.scores.gov.in against registered intermediaries if they are unsatisfied with their responses. SCORES facilitates you to lodge your complaint online with SEBI and subsequently view its status.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.