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How to use mutual funds for long term financial planning
28 Jun 2023

When we appreciate the benefits of long term planning towards our financial goals, we need to focus on the ideal investment vehicle for realizing these goals. Any investment towards your financial plan must have a unique combination. They need to offer a mix of returns, risk, tax efficiency and liquidity. That is where mutual funds fit into your financial plan. Here are 10 reasons why:

1.  You can get automatic diversification

Diversification in mutual fund can be default or by design. You can allocate your funds across equity, debt, liquid and gold to reduce your concentration risk. The mutual funds, per se, also try to reduce your risk by diversifying across asset classes. This gives you a natural risk management over the long run.

2.  Mutual funds are highly liquid

The big advantage in mutual funds is that they are highly liquid. While your plan related investments are for the very long term, there must also be an exigency you may have to fall back on. Disengaging with other assets can be quite expensive. In case of mutual funds, all the categories of funds are highly liquid and involve minimum impact cost.

3.  MFs also score in terms of tax efficiency

Even assuming that you have to pay 10% tax on LTCG on equity funds, the net impact on the CAGR yield is less than 10%. Even debt funds are structured as capital gains with the benefit of indexation benefit for long term gains. This makes mutual funds more tax efficient compared to other asset classes.

4.  Get the mutual fund according to the goal tenure

Tenure matching is one of the key reasons why mutual funds naturally fit into your long term financial goals. You can get an overnight 1-day debt fund to 20-year equity funds and you can just peg such products directly into your goals. This will also reduce the risk of maturity mismatch in your long term financial plan.

5.  Adopt the SIP approach to long term planning

Systematic investment plan is an option you have in case of equity and debt funds. Especially, when you are trying to build wealth over the long term, SIPs add a lot of value there is no need to worry about timing the markets. It is time that works in your favour and reduces your average cost of holding over a period of time.

6.  Equity funds are great wealth creators in the long run

That is perhaps the most important reason for holding equity funds in your financial plan. For an investor they are just passive investments but can tremendous wealth over the long run. Even with conservative returns, equity funds can generate substantial wealth if the discipline of SIP is sustained over long periods of time. Consider the table below:

SIP5-Year SIP10-Year SIP15-Year SIP20-Year SIP25-Year SIPMonthly SIPRs.10,000Rs.10,000Rs.10,000Rs.10,000Rs.10,000Yield (%)14%14%14%14%14%Total outlayRs.6.00 lakhRs.12.00 lakhRs.18.00 lakhRs.24 lakhRs.30 lakhFinal WealthRs.8.72 lakhRs.26.21  lakhRs.61.29 lakhRs.1.32 croreRs.2.73 croreWealth Ratio1.45 times2.18 times3.41 times5.50 times9.10 times

The longer you save the more your principal earns returns and the more your returns earn further returns. That is the power of compounding that the above table captures.

7.  Peg mutual fund units to specific goals

The advantage of financial planning is that you can define your long term goals and assign a value to it. Then you just work backward based on realistic return assumptions and start the SIP. Give the SIP a specific name to indicate that it is pegged to a particular goal. That makes your entire planning process a lot simpler.

8.  Manage retirement corpus through mutual funds

When you plan for your retirement you need to make the power of equities work in your favour. At the same time, you also need to ensure that on retirement these funds are invested in the form of a systematic withdrawal plan (SWP) so that you combine the best of withdrawal and debt market returns. Alternatively, you can also directly opt for a retirement plan of a mutual fund.

9.  Manage your child’s education through mutual funds

Managing your child’s education expenses calls for aggressive equity investing and also for planning milestone payments. You can manage both through mutual funds by appropriately shifting from equity funds into debt or liquid funds through STPs. Alternatively you can also opt directly for children planning funds. However, managing your insurance needs and your investment needs separately is always advisable.

10.  Dynamic plans are available if you are more aggressive

If all these approaches appear to be too passive for your liking, then you also have the choice of dynamic allocation. Here the fund manager takes the call on market valuations, P/E ratios, interest rates etc and tries to tweak your portfolio accordingly. Use this approach sparingly and be aware of the risks involved.
Mutual funds, therefore, offer you the best variety and dynamism to meet your long term financial goals. Make it a necessary part of your financial plan.

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