How to Select Mutual Funds for Retirement Planning?

Every working employee has to retire one day, and thus, it is necessary to start accumulating funds and plan your retirement now. Among various types of securities, mutual funds are a good type to invest in. Here, as an investor, you will not have to take out time and invest in managing funds, whereas professionals will take care of this task.

However, before starting your investment journey, it is important to consider some factors related to mutual funds for retirement.

Some categories of mutual funds that can be suitable for you to start investing in for retirement are as follows:

1. Equity Mutual Fund Schemes

Here, the investment majority occurs among equity-related instruments and are generally recognised as large, mid, and small-cap stocks, depending on your particular scheme.

2. Debt Mutual Fund Schemes

Investment in these funds generally occurs in the money market and debt market securities. Moreover, they can be further sub-categorised depending on the funds' nature and maturity period.

3. Hybrid Mutual Fund Schemes

Hybrid fund schemes are a combination of both equity and debt mutual funds. This means they have a combined feature of both these fund types.

4. Solutions Oriented Mutual Fund Schemes

Solutions-oriented funds come in two different categories, i.e., retirement funds and children's funds. You can withdraw funds from this scheme only after 5 years or till your retirement age (whichever comes earlier).

5. Other Mutual Fund Schemes

Some other mutual fund schemes where you can invest are Fund of Funds (FOFs) and Index Funds or Exchange Traded Funds (ETFs).

Some basic things you must keep in mind before investing in mutual funds for retirement are as follows:

1. Invest in Funds Giving Consistent Returns

Consistency of returns is the hallmark of a good mutual fund. It helps in regulating losses and thereafter, poses a high chance of giving good returns. For instance, a scheme giving you around 5% returns every year is better than another scheme giving you 8% and 2% in two consecutive years.

2. You Cannot Receive Equal Returns Every Year

We all know that mutual funds generate annual returns. However, this does not mean you will make the same earnings via mutual funds yearly. For instance, your invested mutual fund scheme gave you 8% returns in one year but generated a 2% return in the next year. In addition, during some financial years there will be no or negative returns.

3. For Higher Returns, Invest in Direct Plans

Direct plans can produce higher returns due to their lower expense ratio. This expense ratio is the maintenance charge levied annually by the mutual funds. Moreover, these direct plans have lower expenses because of the non-involvement of brokers charging brokerage. 

4. Try SIP to Create Investment Discipline

SIP is a method by which you can automate your contributions towards a mutual fund periodically. This type of investment practice creates discipline, which helps you benefit from market volatility. Moreover, you can generate good returns via the Rupee Cost Averaging by gaining more returns as the market falls.

5. Focus on Asset Allocation Process

Investing all your funds in one asset class may cause huge risks. Hence, you should divide your investment among various asset classes by asset allocation process. This will not only help reduce portfolio risk but also help plan where and how much to invest.

6. Periodic Rebalancing to Earn More Profits

Period rebalancing is necessary to benefit from asset allocation. Here, rebalancing means whenever an asset class or its percentage increases in your portfolio, you earn profits that get reinvested in other asset classes which are a part of your portfolio.

7. Not All Mutual Fund Categories Have the Same Risks

On the basis of any common parameter or scale, you cannot distinguish a particular mutual fund to pose a higher or lower risk than the other. Therefore, before investing in a mutual fund, it is advisable to check its associated risks. Although each scheme involves risk, you must identify the most suitable one.

Certain things to keep in mind while selecting mutual funds for retirement are as follows:

1. Financial Goals

Estimating or setting specific financial goals is important before investing in a mutual fund. After this, you should understand your return expectations, based on which you can diversify your portfolio among suitable mutual funds. Moreover, by having such specific goals, you can avoid overspending and clearly understand all your expenses.

2. Risk Intake Capacity

Some mutual funds hold more risk than others. However, identifying a mutual fund to be riskier than the other depends totally on your risk intake capacity. This risk appetite depends on age, finances, medical, and other personal reasons. If you can analyse your risk intake capacity effectively, it will be easier for you to identify the most suitable mutual fund.

3. Expense Ratio

The expense ratio is measured as a percentage of the annual maintenance cost levied by the mutual fund to its actual asset value. Therefore, you can classify it as the commission you charge as an investor to ensure profit from investments. As an investor, selecting such mutual funds with a low expense ratio for investment is always recommended. 

4. Liquidity

It is also essential to consider the liquidity of your mutual funds before choosing the right one and investing in it. This is because depending on whether you need to withdraw funds sooner or later greatly influences the type of mutual fund you choose. For instance, you can invest in liquid funds if you withdraw them soon. Otherwise, you can invest in equity mutual funds if you want to withdraw it later. 

5. Taxes

A good knowledge of tax consequences on various types of mutual funds is essential before selecting a suitable mutual fund. For instance, mutual funds with long-term capital gain provide exemption up to ₹1 Lakh and the remaining amount is taxed at 10%. Whereas a mutual fund generating short-term capital gains has no exemption, the return here is taxed at 15%.

The advantages of retirement planning through mutual funds investment are as follows:

1. Risk Diversification

By investing in mutual funds, you can diversify your portfolio across many asset categories and securities like gold, equity, etc., which will also help reduce the risk of returns.

2. Management by Professionals

A mutual fund is managed by full-time professionals who make investment easier for you if you lack knowledge or time to research.

3. Affordability

Mutual funds are affordable due to their low expense ratio and huge economies of scale. Moreover, you can start investing here initially with a minimum investment value which is comparatively more affordable than other such securities.

4. Liquidity

It is possible to easily liquidate your funds and manage financial emergencies in case of an open-ended mutual fund scheme. Therefore, if you tend to withdraw your funds soon, invest in this category of the fund.

5. Tax Exemptions

On investing in a mutual fund, you can claim tax deductions of up to ₹1.5 Lakhs under section 80C of the Income Tax Act, 1961. Keep in mind to hold investments for a longer duration to make them more tax efficient.

The disadvantages that you might come across after investing in a retirement mutual fund in India are as follows:

1. Fluctuating Returns

Mutual funds do not offer any guaranteed returns; thus, you will not receive stable returns on investing here. Moreover, professional managers will not insulate you previously from any bad performance caused by the fund you invested in.

2. No Self-control

As an investor, you will have no control over your investment. This is because mutual funds are controlled and managed by professionals or their team of analysts only.

3. Profit Dilution

Portfolio diversification in the case of mutual funds can have benefits as well as disadvantages. Although it helps you reduce losses, it can also restrict profit growth if you invest in too many mutual funds at a time.

4. Fund Management Costs

While selecting a mutual fund, you should also consider its management costs, as the investor will finally have to bear it. This management charge can sometimes be very high, which might not guarantee a fund's better performance. 

Therefore, now you have a clear idea of the categories of mutual funds to invest in when retirement is more than 15 years away. There are multiple benefits of investing in mutual funds for retirement, which you can claim if you consider certain factors before starting your investment journey. However, despite the several advantages it provides, there are certain disadvantages which you may come across while investing.