Deepa Menon (an illustrative profile) is 38, a doctor in Mumbai, and holds fourteen mutual funds. Some came from a bank relationship manager, some from colleagues' tips, and a few were bought because they topped a returns table. She invests about ₹60,000 a month across them but cannot say what each one is for, and she suspects several hold the same companies.
"Which is the best mutual fund?" is the question most investors ask, and it has no single answer. The right fund is one whose mandate, risk and cost fit a clear role in your plan. This chapter gives you a framework for choosing funds and a calm process for reviewing them.
In this chapter
- Why the goal and asset allocation come before any fund
- Seven checks to run before choosing a fund
- How to spot overlap and keep a portfolio simple
- When to rebalance, when to replace a fund, and what switching really costs
Step 1: Goal and allocation before fund
Write down each goal, the amount, the date and how flexible that date is. Then decide your asset allocation, meaning the split of your money between equity, debt and cash. Research on diversified portfolios consistently finds that this mix explains most of the ups and downs investors experience, far more than the choice between two similar funds.
A simple guide: money needed within three years generally should not be in equity; money for goals three to seven years away can use a balanced mix; money for goals beyond seven years can usually take more equity risk, if you can tolerate the swings. Only once the mix is set do you choose funds to fill each slot.
Step 2: Seven checks before you choose
| Check | What to look at | Why it matters |
|---|---|---|
| 1. Category fit | Is this SEBI category right for the goal and horizon? | The wrong category is the costliest mistake |
| 2. Risk and portfolio | Riskometer, top holdings, sector weights, concentration | Tells you what you actually own |
| 3. Benchmark and peers | Returns against the total-return benchmark and category peers | Shows whether the manager has added value |
| 4. Consistency | Rolling 3- and 5-year returns; behaviour in falls | Separates skill from one lucky year |
| 5. Costs | Expense ratio against category peers | Costs compound against you |
| 6. Process and people | Investment style, team tenure, fund size | A good record from a team that has left may not repeat |
| 7. Overlap | Common holdings with funds you already own | More funds can mean less real diversification |
Rolling returns deserve a word of explanation. Instead of measuring a single period, such as "the last three years", they measure every three-year window over a longer span, for example every three-year period starting each month for the past ten years. This shows how often the fund beat its benchmark and how bad its worst windows were, which a single number hides.
Why not just pick last year's winner?: One-year returns depend heavily on start and end dates, and leadership rotates between styles, sectors and company sizes. A fund at the top of last year's table may simply have taken more risk in a good year. SEBI's standard disclosure says it plainly: past performance may or may not be sustained in future.
Step 3: Keep the portfolio simple
Deepa's fourteen funds include five large cap and flexi cap funds. Because large cap funds must hold at least 80% in the same 100 companies, these funds probably share many top holdings. Owning five of them is like ordering five different brands of the same dal: more variety on the label, much the same in the bowl.
Many investors are well served by four to six funds in complementary categories, for example a large cap or index fund as the core, a flexi cap fund, a mid or small cap allocation sized to their risk appetite, and one or two debt or hybrid funds for stability and near-term goals. Fewer, clearly purposeful funds are also far easier to review, rebalance and hand over to family.
Step 4: Rebalance with discipline
Markets move your mix away from its target. After a strong rally, equity becomes a larger share than you planned, which means more risk than you signed up for. Rebalancing means moving money back to the target, which mechanically sells a little of what has risen and buys what has lagged.
Worked example: rebalancing a 60:40 portfolio. Assumptions (illustrative): ₹20 lakh invested as ₹12 lakh equity and ₹8 lakh debt. Over two years, equity rises 40% and debt 6%.
- Equity = ₹12 lakh × 1.40 = ₹16.80 lakh. Debt = ₹8 lakh × 1.06 = ₹8.48 lakh. Total = ₹25.28 lakh.
- Equity share = ₹16.80 lakh ÷ ₹25.28 lakh ≈ 66.5%, well above the 60% target.
- Target equity = 60% × ₹25.28 lakh ≈ ₹15.17 lakh. Amount to move ≈ ₹16.80 lakh − ₹15.17 lakh ≈ ₹1.63 lakh from equity to debt.
- To limit tax, first direct new SIPs into debt, use units already held over 12 months, and stay within the ₹1.25 lakh exemption where possible.
A common rule of thumb is to rebalance when an asset class drifts more than five percentage points from its target, or once a year, whichever comes first.
Step 5: Review, but do not overreact
Review once or twice a year. The question is not "did this fund top the table?" but "is it still doing the job I hired it for?"
| Consider replacing a fund when… | Usually not a reason on its own |
|---|---|
| Its mandate, category or benchmark changes, or it is merged | One or two quarters of underperformance |
| The investment process or key team changes materially | A fall in line with its category during a market correction |
| It has trailed its benchmark and peers over several rolling periods | A friend or social media post recommending something else |
| Its risk no longer fits your goal, or costs become uncompetitive | A new fund launch with an exciting theme |
Worked example: what a hasty switch costs. Deepa wants to move ₹5 lakh out of a fund she bought eight months ago, now showing a ₹60,000 gain, with a 1% exit load within a year.
- Exit load = 1% × ₹5 lakh = ₹5,000.
- Short-term gain after the load = ₹60,000 − ₹5,000 = ₹55,000. Tax at 20% = ₹11,000, plus cess = ₹11,440.
- Total cost ≈ ₹16,440, about 3.3% of the amount, lost the day she switches.
- Waiting four more months would avoid the exit load, and the gain would become long-term and likely fall within her ₹1.25 lakh exemption.
Common mistakes to avoid
- Collecting funds instead of building a portfolio. Each new fund should fill a gap, not repeat an existing holding.
- Chasing last year's top performer. Rankings rotate, and yesterday's leader often took the most risk.
- Never rebalancing. A portfolio left alone after a rally carries more risk than you planned.
- Switching without counting costs. Exit loads and short-term tax can wipe out the expected benefit.
- Ignoring nominations and records. SEBI now allows up to ten nominees; update them at each review so your family can claim easily.
Try this yourself: List every fund you own with its category, current value and the goal it serves. Mark any two funds in the same category, and any fund you cannot link to a goal. Then add up your equity and debt to find your actual mix and compare it with your target. If the list is longer than you expected, a free portfolio review can help you see overlap and drift clearly.
Frequently asked questions
How many mutual funds should I have?
There is no fixed number, but four to six well-chosen funds in different categories are enough for most families. Beyond that, extra funds usually add overlap and paperwork rather than diversification.
Should I switch funds when the fund manager changes?
Not automatically. Check whether the fund follows a team-based process that continues, whether the new manager has a record in a similar mandate, and whether the portfolio changes sharply over the next few quarters. A material change in process is a reason to review; a name change alone is not.
Should I exit a fund that has underperformed for a year?
Not on that basis alone. Check whether it lagged its own benchmark and category peers over several rolling periods, and whether its mandate or team changed. A fund can lag for a year simply because its style was out of favour.
What is portfolio overlap, and how do I check it?
Overlap is the share of holdings two funds have in common. Compare the top holdings on each fund's factsheet; if the same names dominate both, the second fund adds little diversification.
Read the longer version of this framework in how to choose mutual funds, or request a free portfolio review for a second look at your current funds.
You have completed the module: You can now explain how mutual funds work, compare fund types and costs, choose how to invest and withdraw, work out the tax, and apply a simple framework to choose, rebalance and review funds. When you are ready to put it into practice, start your free review with the Money n Wealth team.