Topic 2: What is Portfolio Tracking and Why Should I do it?
In India, there is no shortage of websites and How To Guides that provide information on how to invest in direct mutual funds, sign up for a KYC (Know Your Customer document), and how to pick a good basket of funds to invest in. The last part is important because each investor has to invest in a portfolio that makes sense for them, taking into consideration their income, financial goals, age and risk-appetite.
When Invested in Mutual Funds, set up a few SIPs. Now what?
While it would be nice to forget about your investments and come back to them in seven years to pleasantly discover that they have doubled in rupee value and beat inflation rates, that unfortunately, wouldn’t be a prudent decision.
It’s important to keep periodic track of your investments to see how they are doing, and to do some reallocation along the way to move your funds according to your changing life circumstances and market performance. This is called portfolio re-balancing, and it’s very important that you have the most up-to-date and accurate information about your portfolio so that you can make the best decisions. If you spend hours tabulating your investment information in a spreadsheet, be careful about calculation errors. We’ve all made them.
If portfolio tracking takes too long for you, it probably means that you’ll lose interest in doing it often enough, and you won’t be able to make informed decisions about your investments.
Mutual Fund Portfolio Tracking & Important Metrics
Here are some important metrics to track when you’re tracking your portfolio:
Fund Allocation
There are different kinds of mutual funds, depending on which type of assets the fund invests in. For instance, equity funds are mutual fund schemes, where more than 65% of the funds are invested in equity shares of domestic companies. Debt funds invest in fixed income instruments such as Corporate and Government bonds, are lower-risk investment options for those looking for better interest rates than their bank’s savings accounts/ fixed deposits.
Keeping a track of fund allocation is important to ensure that it is in line with your risk tolerance and future money requirements. As your portfolio appreciates over time, the ratio of equity:debt could possibly change.
For example, if you start with a 50:50 equity:debt allocation, and if you leave your portfolio untouched for a year, it is possible that by the end of the year, the allocation could have changed to 60:40 based on the rate of appreciation of the funds.
Examples of Fund Allocation:
It’s important to understand the different kind of funds and make sure that you are invested in funds that align with your current income levels, age and financial goals. Following are some general guidelines that you can use when deciding on your fund allocation (but please remember, everybody’s situation is unique):
This is why portfolio re-balancing is important. Take time at periodic intervals (at least once in an year) to see the fund allocation of your investments, and ask yourself if you are on track to meet your goals. Do you have about six months of expenditure in liquid funds for an emergency? If you have a big expense coming up, should you start moving money into a debt fund? These are some of the important checks.
XIRR (Internal Rate of Return)
XIRR is the rate of return applicable to your investments, taking into consideration all the transactions (such as SIPs, redemptions, transfers) that you have initiated since you first purchased a fund. It is a good measure of the return on your investments, and is much more indicative of performance than absolute return because the latter doesn’t reveal what the cost of your investment is. The equation used to calculate XIRR is as follows:
V0(1+r)t0 + V1(1+r)t1 +….. = Vn
Where V0 = value of money at first cash flow (when you first bought the fund, or the value at the date that you want to start the calculation of XIRR from) r = rate of return (which is what we are trying to determine) t0 = time between today and the date of the first cash flow Vn= value of money today. For instance, if we purchased INR 10,000 of a fund on June 1st 2017, V0 = 10,000 Vn would be the value of those funds today, with appreciation. Each time there is an additional purchase of funds or redemption, we add more V’s to the formula, and then we solve to determine the value of r, which gives us the XIRR value. What this calculation allows us to do is prorate the gains on funds depending on the time frame that we have held them for.
Market Comparison
Once you’ve invested in a fund, it’s important to see whether your fund manager is picking the right assets for the portfolio. Two factors that impact the performance of your portfolio are market timing and the selection of assets in your portfolio. Market timing is something that investors cannot fully control. We don’t always have money on hand when the time is ripe for investment, and our investment decisions are often influenced by our own capital flow, which doesn’t always correlate with the market. To demonstrate this, let us take a sample portfolio and look at the equity funds in it. For each fund, we will assign a benchmark index (as an example) depending on the type and size of the fund. The mutual fund industry in India is evolving to provide individual investors with better technological tools and more transparency to help them make more informed decisions about their investments. This is good news! Choose the one that makes the most sense for you and keeping tracking the portfolio to make sure you’re investing wisely.
When Invested in Mutual Funds, set up a few SIPs. Now what?
While it would be nice to forget about your investments and come back to them in seven years to pleasantly discover that they have doubled in rupee value and beat inflation rates, that unfortunately, wouldn’t be a prudent decision.
It’s important to keep periodic track of your investments to see how they are doing, and to do some reallocation along the way to move your funds according to your changing life circumstances and market performance. This is called portfolio re-balancing, and it’s very important that you have the most up-to-date and accurate information about your portfolio so that you can make the best decisions. If you spend hours tabulating your investment information in a spreadsheet, be careful about calculation errors. We’ve all made them.
If portfolio tracking takes too long for you, it probably means that you’ll lose interest in doing it often enough, and you won’t be able to make informed decisions about your investments.
Mutual Fund Portfolio Tracking & Important Metrics
Here are some important metrics to track when you’re tracking your portfolio:
Fund Allocation
There are different kinds of mutual funds, depending on which type of assets the fund invests in. For instance, equity funds are mutual fund schemes, where more than 65% of the funds are invested in equity shares of domestic companies. Debt funds invest in fixed income instruments such as Corporate and Government bonds, are lower-risk investment options for those looking for better interest rates than their bank’s savings accounts/ fixed deposits.
Keeping a track of fund allocation is important to ensure that it is in line with your risk tolerance and future money requirements. As your portfolio appreciates over time, the ratio of equity:debt could possibly change.
For example, if you start with a 50:50 equity:debt allocation, and if you leave your portfolio untouched for a year, it is possible that by the end of the year, the allocation could have changed to 60:40 based on the rate of appreciation of the funds.
Examples of Fund Allocation:
It’s important to understand the different kind of funds and make sure that you are invested in funds that align with your current income levels, age and financial goals. Following are some general guidelines that you can use when deciding on your fund allocation (but please remember, everybody’s situation is unique):
- Young Person at the start of their career, with a secure monthly income: 100% equity -> 50% in large caps, 30% in small/mid, 20% in sectoral. If you know you have a cash flow requirement in the near future, move the fund to a debt or liquid fund once the fund is out of exit load.
- Middle-aged Person approaching retirement: If your source of monthly income is not going to be as frequent once you retire, you have to make sure that your money will be available to you when you need it. This is a good time for you to start moving the quantity of required money into safer debt funds.
This is why portfolio re-balancing is important. Take time at periodic intervals (at least once in an year) to see the fund allocation of your investments, and ask yourself if you are on track to meet your goals. Do you have about six months of expenditure in liquid funds for an emergency? If you have a big expense coming up, should you start moving money into a debt fund? These are some of the important checks.
XIRR (Internal Rate of Return)
XIRR is the rate of return applicable to your investments, taking into consideration all the transactions (such as SIPs, redemptions, transfers) that you have initiated since you first purchased a fund. It is a good measure of the return on your investments, and is much more indicative of performance than absolute return because the latter doesn’t reveal what the cost of your investment is. The equation used to calculate XIRR is as follows:
V0(1+r)t0 + V1(1+r)t1 +….. = Vn
Where V0 = value of money at first cash flow (when you first bought the fund, or the value at the date that you want to start the calculation of XIRR from) r = rate of return (which is what we are trying to determine) t0 = time between today and the date of the first cash flow Vn= value of money today. For instance, if we purchased INR 10,000 of a fund on June 1st 2017, V0 = 10,000 Vn would be the value of those funds today, with appreciation. Each time there is an additional purchase of funds or redemption, we add more V’s to the formula, and then we solve to determine the value of r, which gives us the XIRR value. What this calculation allows us to do is prorate the gains on funds depending on the time frame that we have held them for.
Market Comparison
Once you’ve invested in a fund, it’s important to see whether your fund manager is picking the right assets for the portfolio. Two factors that impact the performance of your portfolio are market timing and the selection of assets in your portfolio. Market timing is something that investors cannot fully control. We don’t always have money on hand when the time is ripe for investment, and our investment decisions are often influenced by our own capital flow, which doesn’t always correlate with the market. To demonstrate this, let us take a sample portfolio and look at the equity funds in it. For each fund, we will assign a benchmark index (as an example) depending on the type and size of the fund. The mutual fund industry in India is evolving to provide individual investors with better technological tools and more transparency to help them make more informed decisions about their investments. This is good news! Choose the one that makes the most sense for you and keeping tracking the portfolio to make sure you’re investing wisely.