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 I have been investing in diversified equity mutual funds over the past six months.

I would like to keep doing so but this time only via a Systematic Investment Plan with select funds. Every month I can devote a total of Rs 15,000 towards this.

I was thinking of focusing on the Equity Linked Saving Schemes of mutual funds and in some mid-cap schemes.

Am I doing the right thing? If you agree, then what would be a good ratio to adopt between the two?

- Kapil Arora

Systematic Investment Plan

You have made the right decision of investing in select funds through the SIP mode.

Too many investors want to time the market when in fact, the market cannot be timed.

The best way to invest in a mutual fund is by regularly investing fixed amounts. When the Net Asset Value is high, you get fewer units for your money. When it is low, you get more units.

Over time it averages out.

For a balanced perspective on the good and bad of SIPs read, How to invest in a mutual fund and Why an SIP is not always great.

Equity Linked Saving Schemes

An ELSS is the mirror image of a diversified equity fund.

This means the fund manager will invest in shares of various companies across various industries.

What sets it apart is the added tax benefit, something a diversified equity fund does not offer.

Investments in ELSSs fall under Section 80C. The limit under this section is Rs 100,000. This is irrespective of how much you earn and under which tax bracket you fall.

Also, there are no sub-limits under this overall Rs 100,000 amount.

So, if you choose, you can invest the entire amount in ELSS or infrastructure bonds. How you utilise the limit of Rs 100,000 is entirely up to you.

All about Section 80C gives you the details about the various investments that fall under this section.

The dividends you earn in an ELSS are tax free.

When you sell the units of these funds, you can benefit from long-term capital gain, under which you don't have to pay capital gains tax. Read All you want to know about capital gain to understand long-term and short-term capital gain tax.

But, it also carries a lock-in of three years. Therefore, you must invest only that much in the ELSS which will help you save tax.

Secondly, you should be comfortable to part with this money for the next three years.

In any other case, diversified equity funds would make more sense than an ELSS. To help you make a choice, read Which ELSS fund should you invest in?

Mid-caps

If the number of shares in a company is multiplied by its current price, the result is market capitalisation.

Based on this figures, companies are categorised as large-cap, mid-cap and small-cap.

When deciding whether or not to invest in mid-caps, there are three steps you must follow.

1. Check to see how much of your existing portfolio has already been invested in mid-caps.

2. Then decide how much percentage of your overall portfolio you want to allocate to mid-caps.

3. Decide whether there is scope to add a mid-cap fund to the portfolio.

Mid-caps have witnessed a tremendous price appreciation over the last year and a half. So they look extremely attractive as of now. For a detailed write up on this, read Why mid-caps are hot.

But, they are very volatile and are susceptible to varying price fluctuations. When the market rises, they rise faster than the large-caps. If the markets fall, they are likely to take a deeper blow than the large-caps.

You should be comfortable with this kind of volatility.

The advantage of a diversified equity fund is that the fund manager has the flexibility to move in and out of mid-caps depending upon his outlook.

However, a mid-cap fund will either invest in mid-caps, or not. If the fund manager believes the stocks are too highly priced or there are not sufficient good companies around, he will leave the money in cash.

Therefore, a diversified fund tends to be more suitable as a core holding for a long-term portfolio. Invest in a mid-cap fund only if you have sufficent money in diversified equity funds.

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