Make Sure You Follow Prudent Approach Before Deploying Windfall Income
Jul 24, 2019

Author: Rounaq Neroy

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Recently, I received a windfall income--a large sum of money--which I wish to invest in mutual funds. Can you please guide me on how do I go about and suggest a few types of mutual fund schemes that I should consider?

V.D. Joshi, Pune

Before I talk about the approach and type of mutual fund schemes, let me first state that I'm unaware of your age, risk profile, investment objectives, the financial goals you are addressing, and the time horizon to achieve the envisioned goals.

That being said, very broadly, here's how you should go about...

  • ✔ Set a cool-down period - meaning, do nothing with the windfall income for a while (a couple of weeks to months), though it's natural to get overwhelmed. Ideally, think through carefully how you can deploy the proceeds productively.

  • ✔ Carefully look into the tax incidence; after all, it's a constitutional duty to abide by.

  • ✔ The windfall will play a crucial role to help you on your rainy day when the need arises. So, if you haven't built a sufficient contingency reserve or a rainy day fund, do it right away. The contingency reserve should at least be 6 months to 12 months of your monthly regular expenses, including the EMIs (Equated Monthly Instalments).

  • ✔ If you have any outstanding debt, reduce or pay off your debt burden, and make it your top priority in the interest of your financial health and wellbeing.

  • ✔ Make sure you're insured optimally--for both, life and health --by reviewing your insurance portfolio. If you are not adequately covered, then use the windfall income to buy/increase your insurance cover. But again, while indemnifying the risk to your life and health be careful about the insurance policy/s you buy and ensure that you are insured with an optimal risk cover. 

  • ✔ Before you invest, thoughtfully attend to important financial goals you and your family have, viz. buying a dream home, child's education, wedding expenses, and your retirement. These financial goals should be S.M.A.R.T (Specific, Measurable, Adjustable, Realistic, and Time-bound). Once you've listed out your financial goals, prioritize them into short-term, medium-term, and long-term.

  • ✔ Thereafter, invest the money sensibly--in various investment avenues, paying attention to the asset allocation that best suited for you--in order to accomplish vital financial goals. Avoid following what your friends, relatives, next-door neighbour when it comes to investments; because investing is an individualistic exercise.

  • ✔ You could spend some money to fulfil materialistic gratifications viz. family vacation, a car, etc.

  • ✔ Lastly, make sure you do not ignore estate planning. It is essential for everyone, irrespective of how much wealth you possess.

Now coming to your question; which type of mutual fund schemes to consider...

As you may know, there are five broad categories of mutual fund schemes: equity-oriented, debt-oriented, hybrid, solution-oriented, and others.

If you have the stomach for high risk, an investment time horizon of at least 5 years, and the broader objective is capital appreciation over the long-term, you may consider parking a portion of the windfall income in equity-oriented mutual funds.

Among the 10 sub-categories of equity-oriented funds, currently looking at valuations and volatility in play, it would be wise to take exposure to multi-cap funds, and some proportion in large-cap funds. The latter would provide some stability to your portfolio, while the former will help you benefit from across market capitalisation segments.

Although valuations in the small-cap and mid-cap space have corrected, and given that the Modi 2.0's full budget 2019 has not enthused the market much, the pure mid-cap funds and pure small-caps funds appear vulnerable with more turbulence in the offing. Do note that the year 2019 is not going to be easy; it could test the patience of several investors.

An economic slowdown, deficient southwest monsoon, lower consumer confidence, among a host of many other factors could weigh on the corporate earnings and consequentially on the performance of mutual fund schemes.

On the other hand, say you are averse to taking very high risk in equities, and therefore wish to invest in debt mutual funds; among the 16 sub-categories, ideally, prefer shorter duration and dynamic style debt funds for an investment time horizon of 2 to 3 years, over longer duration funds.

That said, make sure you approach even short-term debt funds with your eyes wide open and pay attention to the portfolio characteristics and quality of the scheme. Prefer safety of principal over return. Stick to mutual funds where the fund manager doesn't chase returns by taking higher credit risk.

And if you have an extremely short-term time horizon (of 3 to 6 months), and looking for a safer bet, you would be better off investing in overnight funds.  Avoid liquid funds that have very high exposure to Commercial Papers (issued by private entities).

Remember, asset allocation is the cornerstone of investing. Hence, do not ignore it when you build a mutual fund portfolio.

[Read: Why You Should Not Ignore Personalized Asset Allocation While Investing]

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Editor's Note:

If you wish to select the worthy mutual fund schemes to address your future financial needs, I recommend you to subscribe to PersonalFN's unbiased premium research service, FundSelect.

FundSelect is PersonalFN's premier equity mutual fund recommendation service that has beaten the market by over 70% in a decade.

(Source: ACE MF, PersonalFN Research)
Performance as on June 28, 2019; Past performance is no guarantee of future results

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Happy Investing!

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