Selecting a good Mutual fund is a difficult task as it needs reasonable understanding of the industry, analyzing various sectors in which it invests, etc. If you don’t take help of an advisor it can be a difficult task. For this SEBI came up with colour coding of Mutual Funds to determine the riskiness of the fund to help the common investor.
For AMC’s its compulsory to categorize and colour code the mutual fund on the offer document and even on the advertisements.
By this way SEBI helps you in selecting the fund which suites your risk profile.
There are 3 colours assigned to the funds – Yellow, brown & blue.
Blue –
- The colour signifies the fund which has the lowest level of risk.
- These funds (can/might) provide investors average returns.
- Liquid funds, income funds, gilt funds, FMP’s, short term debt funds fall under the blue colour code.
Yellow –
- It signifies that the fund carries moderate amount of risk.
- They provide returns which are above average.
- Balanced funds, MIP’s, Multi-asset funds fall under the yellow colour code.
Brown –
- These funds carry the highest level of risk.
- These funds are suppose to provide potentially high returns.
- Diversified equity funds, sectoral funds, index funds, ELSS, RGESS funds fall under the brown colour code.
How should an investor interpret this?
Investors who can take the maximum amount of risk should invest in funds colour coded in brown. Who falls under this category? Generally People who earn quite a lot and have sufficient money for future. They have extra disposable income. Generally young people who earn good money and have no dependents generally fall under this category.
People who’s risk taking capacity is quite low (once you have kids and dependents) your risk taking capacity decreases. These kind of investors are termed as risk averse and should not invest in funds colour coded in brown.
How can you determine your risk taking capacity?
It’s simple all you have to do is ask yourself a few questions like –
- How much money do you make and save
- How many dependents do you have
- Is your job secure?
- Your saving habits, etc.
Alternatively you can also use a tool which I found on moneycontrol.
Once you know your risk taking capacity you can select the fund which suites your financial needs. [Try out the single goal financial planning tool]
Also check out: Brief overview of Asset Allocation