Here I am going to discuss about Equities as an asset class and the importance of having some portion of the total portfolio either directly or indirectly into this asset class.
Fixed income securities give an investor a sense of security in terms of return on investment and also the principle amount. However due to the fixed rate of return, a portfolio which is heavily weighted towards fixed income may become ineffective in times of high inflation and would eat into the purchasing power of your savings. What this simply means is that 100 bucks saved today in a fixed income security at lets say 8% return would become 108 at the end of the year. So if inflation is at 5% then it would eat into your returns by that much amount. Equities here due to inherent nature of higher risk, higher return is considered a good hedge against inflation.
One may directly invest in equities if he/she understands them as an asset class and is ready to put in time to review it fairly regularly. If not then one must take the route of Mutual Funds or Portfolio Management Services to take exposure to equities as they are professionally managed and understand the risk associated the investments.
The Categories of Mutual Funds are:
Balanced Funds: The objective of these funds is to provide a balance in asset allocation by investing some portions each in fixed income and equities. A typical balanced fund might have a weighting of 60% equity and 40% fixed income. Thus they provide with a good opportunity of investing in a balanced portfolio instead of creating one. They should be part of one’s portfolio, but not entirely as they have risks associated with performance of the Fund Manager and so one must avoid putting all the eggs in one basket.
Equity Funds: These are funds with an objective of generating long term capital appreciation with some income by investing in stocks. There are different styles or themes that a mutual fund is bases its return objectives on. The fund may narrow down its focus to either large cap or mid and small cap companies. These funds generally benchmark their returns to an index they link their investment objective to, like the Nifty.
Index funds: These are funds that try to replicate the returns of an index and hence the term. An investor in an index fund believes that most fund managers can’t beat the market. Due to passive style of investment management, these funds carry lower charges than its actively managed peers and hence also attract attention.
Sectoral funds: They may target specific sectors of the economy such as financial, technology, infrastructure, health, etc and try and achieve higher returns than a diversified portfolio. Due to cyclical nature of businesses, these funds are generally more volatile and thus one should have only a limited portion of their assets in this category of mutual funds.