How To Build an Equity Portfolio with Gains from Liquid Funds

The key to potentially growing your wealth over time is to invest it wisely. A strategy used by some mutual fund investors is to use the gains from liquid funds (which are debt mutual funds) to build an equity portfolio.

Liquid funds are low risk and have a higher return potential than most savings accounts, making them a good short-term investment avenue. However, to achieve higher returns and potentially grow your wealth substantially in the long-term, equity funds are more suitable.

Reinvesting gains made from liquid funds into equity funds, therefore, can be a way to combine the benefits of both worlds. Let’s take a closer look at how to build an equity portfolio with gains from Start by evaluating the gains you have made from your liquid fund investments. Check the returns and decide funds, and when to transition from one to another. 

• Table of contents

1. Understanding equity and its role in long-term wealth creation
2. Understanding liquid funds
3. Benefits of this strategy
4. Transitioning from liquid funds to equity
5. Factors to consider

Understanding equity and its role in long-term wealth creation

An equity portfolio is a collection of stocks and shares. You can invest in equities either directly through the stock market, or through equity mutual funds. When you invest in equities, you essentially purchase shares of publicly listed companies. Investors make money if these shares increase in value over time.

Equity investments can aid wealth creation because of their superior return potential in the long term when compared to debt securities and other traditional savings avenues.  

Understanding liquid funds

These are a type of debt mutual fund that invests in short-term money market instruments like treasury bills, commercial paper, and certificates of deposit with maturity up to 91 days. They offer high liquidity and are considered low-risk investments.

Transitioning from liquid funds to equity

While several investors begin their investment journey directly with equity mutual funds, another strategic approach could be to first park funds in a short-term avenue such as liquid funds and then transition to equities. This strategy could be useful for:

• Investors who do not know which fund to choose but want to park their money in an avenue with modest return potential rather than leave it idle in their savings accounts.
• Investors saving up for a lumpsum amount that they will then invest in equity.
• Risk-averse investors who want to invest in equities as well as low-risk avenues.
• Investors choosing a Systematic Transfer Plan (STP). An STP allows you to transfer a fixed amount or a fixed number of units from one mutual fund to another at regular intervals.

Benefits of this strategy

• Risk mitigation: By initially investing in low-risk liquid funds, you reduce the risk associated with market volatility. By transferring only gains from liquid funds into to equity funds, investors keep their principal relatively stable.
• Rupee cost averaging: Using an STP to transfer gains to equity funds allows you to benefit from rupee cost averaging. By investing a fixed amount regularly, you buy more units when prices are low and fewer units when prices are high, potentially lowering the average cost per unit over time.
• Liquidity and flexibility: Liquid funds offer high liquidity, ensuring that your money is not locked in. You can easily adjust your strategy based on market conditions or personal financial needs.

Steps to transition from liquid fund gains to equity investments

• Assess your liquid fund gains: Start by evaluating the gains you have made from your liquid fund investments. Check the returns and decide how much of these gains you are willing to reinvest into equities.
• Understand your investment goals:Determine what you want to achieve with your equity investments. Your goals could range from desiring a steady income stream to exponential growth. The goal will help you decide the type of equity funds to invest in.
• Choose the right equity funds: Select equity funds that align with your investment goals and risk tolerance.
• Diversify your investments: To mitigate risk, it is advisable to diversify your investments across equity fund types and sectors.

Factors to consider

When transitioning from liquid funds to equity funds, investors should keep the following in mind:

Risk tolerance: Equities are riskier compared to liquid funds. Understand your risk tolerance before investing. If you are uncomfortable with high risk, consider allocating a smaller portion of your liquid fund gains to equities.

Investment horizon: Equities are suitable for long-term investments. Ensure that you do not need the money in the short term. A longer investment horizon helps you ride out market volatility.

Market conditions: While timing the market is not recommended, be aware of current market conditions. Avoid investing a large sum during a market peak. Consider averaging out your investments over time through an STP or an SIP.

Financial goals: Align your equity investments with your financial goals. If you have short-term goals, keep some funds in relatively stable investments like liquid funds.

Liquidity needs: Ensure you have enough liquidity for emergencies. Do not invest all your liquid fund gains into equities. Keep a portion in liquid funds for easy access.

Conclusion
Building an equity portfolio with gains from liquid funds can be a smart strategy for long-term wealth creation. Instead of letting your money remain idle in your savings account, you can leverage the return potential of liquid funds and then invest these gains systematically into equities. Remember to consider your risk tolerance, investment horizon, and financial goals before making any decisions. Consult a financial advisor when making major investment decisions.

FAQs

What are the advantages of building an equity portfolio with gains from liquid funds?
The main advantage is the potential for higher returns compared to keeping all your money in liquid funds. Moreover, combining liquid funds with equities can help create a balance between risk mitigation and return potential.

How to decide the proportion of liquid fund gains to allocate to equities?
This depends on your risk tolerance, investment goals, and financial needs. A balanced approach could be to start with a small investment and increase it as you become more comfortable with equity investments.

What are the typical returns I can expect from an equity portfolio built with liquid fund gains?
While past performance is not a guarantee of future returns, historically, equity portfolios have provided higher returns compared to liquid funds over the long term. Expect variability in the short term but potential for significant growth in the long run.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.