Fund Query: Why investing in mutual funds is better than directly buying mid- and small-cap stocks now

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I am 38, married for three years. I am self -employed, a freelancer. My aggregate earnings stand at ₹1 lakh a month. I am an individual with moderate to high risk appetite. I am not into any financial products such as life insurance and health insurance. I have no retirement corpus and have minimum bank liabilities. About 10 per cent of my investments go into SIPs and REITs with no time horizon. I am not into stocks and bonds . I want to know if this is the right time to start trading and which mid- and small-cap stocks are ideal to add to my portfolio.

Vikas Reddy Gandluru

Just when we thought we no longer need to worry much about Covid-19, here it is, in full force, destroying lives and livelihoods. This brings out the importance of insuring both your health and your life. More so, in your case, as you are a freelancer and fluctuating income levels mean that any huge medical expenses can eat into your savings.

Thus, insurance should take precedence over any additional investments that you may want to make, either in mutual funds or stocks or bonds. Go for a term insurance plan that covers at least 10-15 times your annual income. It should be reviewed and adjusted over the years to factor in a rise in your income/expenses as well as any big liabilities such as a home loan or other loans you may take on.

For health insurance, choose a comprehensive health policy and go for a family floater, covering yourself and your spouse. To begin with, you can opt for a cover of at least ₹10 lakh and raise it over the years to factor in higher medical costs as well as additions to your family.

Create an emergency corpus of at least 6-12 months’ expenses from the amount lying in your bank account, if you haven’t already. You can do so by creating flexi-deposits or sweep deposits, which are available on tap; else, you can earmark any FDs you may have, towards this. This will be useful to tide over income shortfalls at any point in time, considering that you are a freelancer and that job losses and salary cuts have been the norm in the last year.

Once these hygiene factors are taken care of, you can step up your savings to at least 20 per cent of your monthly earnings, assuming that you earn ₹1 lakh a month reasonably regularly. You have stated that you are currently investing in SIPs but have not mentioned the details. Hence we are unable to comment on your funds or your allocations to the same. Since you have stated that you have a moderate to high risk appetite, you can choose equity funds to save towards long-term goals such as retirement. A return expectation (CAGR) of 10-12 per cent on this portfolio is ideal.

REITs are an emerging investment option for retail investors and can be considered as part of your stock portfolio. Listed REITs are currently giving a distribution yield of 5-6 per cent, which is comparable to deposit rates. But remember, REITs are also subject to capital gains or loss due to market price movement and there is a minimum trading lot of 200 units. Make sure you don’t have concentrated holdings in them.

After a massive rally since March 2020, stock markets have turned volatile now. If you are not a seasoned investor in stocks, you need to be a bit cautious before you begin taking exposure to mid- and small-cap stocks at this point in time. A better way to go about would be to invest in mutual funds that invest in these segments of the markets.

But remember, the downside for pure mid- and small-cap funds will be higher if the market goes into a prolonged correction at this point. Hence, your investments could go through an erosion first before moving up and delivering over the long-term. If you don’t have an appetite for this, you can choose large- and mid-cap, multi-cap and flexi-cap funds that take exposure to the mid- and small-cap categories. These can help limit downside. Choose funds rated 3- to 5-star in BL Portfolio’s Star Track MF Ratings. Remember to have at least a 7 to 10-year horizon in mind before you take the plunge.

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