How good is long term investing through smart beta ETFs ?

Ans: ETF (Exchange Traded Fund) is just a way of investing and not an investment as such. There are ETFs of everything – equity, debt etc. So the basic tenets of asset allocation have to be followed and take ETFs which meet your requirements.

ETFs, being exchange traded, are traded on a regular basis (if there is enough liquidity available) like stocks and hence, the price fluctuates with trading unlike the mutual funds where the NAV (Net Asset Value), which is largely akin to its price, gets known only at the end of the day.

Hence, there is nothing like ETFs being suitable or unsuitable for your requirement after retirement. If you decide that you will have your portfolio invested in say, 60% debt (ie, safe investments) and 40% equity, and an ETF exists for some or all of your investment requirement, you can go for it.

Ans: Firstly, let me appreciate your initiative and discipline in investing. At 29, you are already taking significant steps towards securing your financial future. Your current SIPs total Rs. 30,000 per month across various funds, and you’re wisely looking at a long-term horizon of 20 years. Let’s dive into your investment strategy and evaluate how to optimize it for achieving your goals.

Review of Current Investments
Your portfolio is diversified across flexi-cap, small-cap, mid-cap, and multi-cap funds, including an index fund. This mix is good for spreading risk and capitalizing on growth opportunities in different market segments. Each type of fund has its characteristics, benefits, and risks.

Assessing the Current Portfolio
1. Portfolio Diversification:

Your portfolio's diversification is commendable. You have invested in various fund categories, which is crucial for risk management.

2. Allocation Breakdown:

Flexi-cap Funds: 50% allocation.
Small-cap Funds: 17% allocation.
Mid-cap Funds: 20% allocation.
Multi-cap Funds: 13% allocation.
3. Risk and Return Balance:

This allocation provides a balance between high growth potential (small and mid-cap funds) and stability (flexi-cap and multi-cap funds).

Enhancing Your Investment Strategy
1. Increase SIP Amount Periodically:

Consider increasing your SIP amount by 10% annually. This will significantly enhance your corpus over the long term. For example, increasing your SIPs yearly can amplify your investment growth, thanks to the power of compounding.

2. Regular Portfolio Review:

Review your portfolio's performance at least once a year. This ensures you stay aligned with your financial goals and make necessary adjustments.

3. Rebalancing:

Rebalancing helps maintain your desired asset allocation. It involves selling some investments that have performed well and buying more of those that haven’t, to maintain a target allocation.

Power of Compounding
Compounding is your best friend in long-term investing. The longer you stay invested, the more your money works for you. Reinvesting your returns leads to exponential growth.

1. Long-Term Growth:

Compounding allows your investments to grow faster as you earn returns on both your initial investment and the accumulated returns over time.

2. Patience Pays:

The key to benefiting from compounding is patience. Stay invested for the long haul and avoid the temptation to withdraw funds prematurely.

Advantages of Mutual Funds
1. Professional Management:

Mutual funds are managed by experienced fund managers who make informed investment decisions on your behalf.

2. Diversification:

They offer diversification across various sectors and asset classes, reducing the risk of significant losses.

3. Liquidity:

Mutual funds are highly liquid, meaning you can redeem your investments relatively easily when needed.

4. Flexibility:

There are various types of mutual funds to suit different risk appetites and investment goals.

Evaluating Fund Categories
1. Flexi-Cap Funds:

These funds invest in companies of all sizes and offer flexibility and diversification. They adjust their portfolio mix based on market conditions, aiming for optimal returns.

2. Small-Cap Funds:

Small-cap funds invest in smaller companies with high growth potential but come with higher volatility. They can offer substantial returns over the long term if you can withstand short-term market fluctuations.

3. Mid-Cap Funds:

Mid-cap funds invest in medium-sized companies with strong growth prospects. They strike a balance between the stability of large-caps and the high growth potential of small-caps.

4. Multi-Cap Funds:

Multi-cap funds invest across large-cap, mid-cap, and small-cap stocks. They provide a balanced approach, reducing risk while aiming for growth.

5. Index Funds:

Index funds aim to replicate the performance of a specific market index. They offer lower expense ratios but might not outperform the market. Actively managed funds, like those you have, seek to outperform market indices through active stock selection.

Risks and Mitigation
Investing in mutual funds involves certain risks, but these can be managed:

1. Market Risk:

Diversify across various asset classes and sectors to spread risk.

2. Interest Rate Risk:

Maintain a mix of equity and debt funds to mitigate the impact of interest rate fluctuations.

3. Credit Risk:

Invest in funds with high credit ratings to minimize default risk.

4. Inflation Risk:

Equity funds can potentially outpace inflation, preserving the purchasing power of your investments.

Tax Implications
1. Long-Term Capital Gains (LTCG):

Gains from equity funds held for more than one year are taxed at 10% for amounts exceeding Rs. 1 lakh annually.

2. Short-Term Capital Gains (STCG):

Gains from equity funds held for less than one year are taxed at 15%.

3. Tax-Saving Funds:

Consider investing in Equity Linked Savings Schemes (ELSS) for tax benefits under Section 80C.

Role of a Certified Financial Planner
A Certified Financial Planner (CFP) can provide valuable guidance:

1. Personalized Advice:

CFPs offer tailored advice based on your unique financial situation and goals.

2. Portfolio Management:

They help monitor and rebalance your portfolio to ensure it aligns with your objectives.

3. Tax Planning:

CFPs offer strategies to optimize your tax liabilities, maximizing your investment returns.

Final Insights
Your investment strategy is on the right track. With consistent SIPs, regular reviews, and periodic rebalancing, you can achieve your financial goals. Here are some key takeaways:

1. Increase SIPs Annually:

Boost your investment amount by 10% each year to leverage the power of compounding.

2. Monitor Performance:

Keep an eye on your portfolio’s performance and make adjustments as needed.

3. Diversify:

Continue diversifying across various fund categories to manage risk and maximize returns.

4. Stay Informed:

Keep yourself updated on market trends and fund performance to make informed decisions.

5. Seek Professional Guidance:

Consider consulting a Certified Financial Planner for personalized advice and ongoing portfolio management.

Your commitment to long-term investing is commendable. Stay disciplined, be patient, and let the power of compounding work its magic. You are well on your way to achieving your financial aspirations.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in

Ans: Your plan to invest Rs 1.4 lakh per month into various smart beta ETFs, including gold, shows a thoughtful approach towards long-term wealth building. It reflects your ambition to achieve a Rs 10 crore corpus in the next 10 years. Let's break down and evaluate this strategy in terms of asset allocation, risk diversification, and alignment with your financial goals.

Portfolio Diversification
Your current portfolio is highly ETF-centric, which includes allocations to mid-cap, small-cap, pharma, and gold ETFs, among others. While smart beta ETFs offer an innovative approach to investment, it's crucial to assess whether this level of concentration is ideal for your goal of corpus creation.

Overconcentration on ETFs: While ETFs offer cost efficiency and diversification, relying heavily on them could expose you to higher volatility, especially in small- and mid-cap spaces. Consider balancing it with actively managed funds, as they can add a layer of expertise, especially in unpredictable market conditions.

Gold Allocation: Investing Rs 50,000 per month in Gold ETFs, about 35% of your total monthly investment, is quite significant. Although gold acts as a hedge, it tends to perform well only in specific scenarios, such as during economic uncertainties. Maintaining a lower allocation to gold, around 10-15%, would reduce the risk of opportunity loss from other high-growth assets.

Smart Beta ETFs: Advantages and Limitations
You are already aware of the benefits of smart beta ETFs, but they also come with some limitations. Here’s an analysis:

Benefits of Smart Beta ETFs: These ETFs attempt to outperform traditional index funds by focusing on factors like momentum, value, and low volatility. They offer transparency and lower fees compared to actively managed funds.

Limitations: Smart beta ETFs can sometimes lag in changing market conditions. Unlike actively managed funds, they do not adjust quickly to market trends. This can be a limitation in times of market correction or when there's a downturn in a particular sector.

Since your plan focuses on ETFs, I would suggest supplementing this with some actively managed funds to make your portfolio more adaptable to changes in the market.

Disadvantages of Index Funds
Index funds, while popular for passive investing, have inherent drawbacks in certain contexts:

Limited Growth Potential: Index funds generally track the market. This can limit the potential for significant outperformance during high-growth phases. Over-reliance on them can cap your upside.

Less Flexibility: Unlike actively managed funds, index funds do not have the flexibility to react to market changes. This rigidity can work against you in a dynamic market, especially when pursuing long-term growth targets like yours.

Thus, while ETFs are cost-effective, introducing more actively managed funds could boost performance over time.

Corpus of Rs 50 Lakh for Market Corrections
Your approach of keeping Rs 50 lakh aside for investing during market corrections is prudent. Here are a few suggestions to optimise the deployment of this corpus:

Phased Investments: Avoid timing the market too aggressively. Consider deploying the Rs 50 lakh corpus through a Systematic Transfer Plan (STP) over 6-12 months, especially during volatile phases. This approach reduces the risk of investing all at once at a market peak.

Diversified Deployment: Distribute the Rs 50 lakh across equity and debt funds. This will allow for growth opportunities while ensuring some stability. High exposure to equity ETFs alone may not serve the purpose during downturns.

Opportunities Beyond ETFs: A part of this corpus can be allocated towards actively managed mutual funds with proven track records. Funds focusing on large-cap and multi-cap categories could help enhance stability during corrections.

Risk Analysis and Asset Allocation
Your current allocation leans heavily toward equities, with a substantial focus on mid-cap, small-cap, and sector-specific ETFs like pharma. While this has a high growth potential, it increases your portfolio’s risk profile. Here are some observations and recommendations:

Sector-Specific Risk: Allocating to sector-specific funds like pharma ETFs adds concentration risk. The performance of such sectors can be cyclical, and being too heavily invested in one sector may limit your ability to recover during downturns.

Volatility of Small and Mid-Cap Funds: Small-cap and mid-cap ETFs are known for their volatility. They can offer high returns but can also lead to significant drawdowns. Diversifying your exposure into some large-cap actively managed funds would be advisable.

Gold Exposure: While gold serves as a good hedge, an allocation of 35% is on the higher side. Reducing it to about 10-15% would allow you to allocate more to equity, where you can achieve better long-term returns.

The Importance of Actively Managed Funds
Better Flexibility and Expert Management: Actively managed funds offer professional expertise in stock selection and market timing, which can enhance returns, especially during volatile markets.

Dynamic Strategy: Unlike passive ETFs, actively managed funds can adapt quickly to market conditions. In a volatile or corrective market, this agility can help protect your portfolio while still allowing for significant growth.

Historical Outperformance: Many actively managed funds have outperformed passive strategies over long time periods, especially in the Indian market. These funds can provide higher returns, particularly in equity-heavy portfolios.

Recommendations for Asset Reallocation
To achieve your goal of Rs 10 crore in 10 years, you may need to rethink your allocation and mix it with more actively managed funds:

Lower Gold Allocation: Reduce your gold ETF contribution from Rs 50,000 to Rs 20,000 per month. This allows you to invest the remaining Rs 30,000 into growth-focused mutual funds.

Balance Sector Exposure: Consider reducing sector-specific ETFs like pharma. Reallocate part of it to more diversified funds, focusing on large- or flexi-cap categories.

Increase Actively Managed Exposure: Introduce actively managed large-cap or multi-cap mutual funds into your portfolio. These funds can provide more stability and still offer growth over the long term.

Maintain the Rs 50 Lakh Corpus for Corrections: Continue with your plan to deploy the Rs 50 lakh corpus in phases during market corrections. However, consider a more diversified allocation across equity and debt funds.

Final Insights
You have an ambitious goal of reaching Rs 10 crore in 10 years, and your dedication is evident. However, a more balanced portfolio, with exposure to both ETFs and actively managed funds, will help you navigate market volatility and maximise your returns.

Balanced Allocation: Reassess your allocation to sector-specific and small-cap ETFs, as they can be volatile.

Gold: Reduce your monthly gold allocation and direct more towards equities.

Phased Deployment: Continue with phased deployment of your Rs 50 lakh corpus during market corrections.

Active Funds: Introduce actively managed funds for better market adaptability and potentially higher long-term returns.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in