For people who wish to enter the stock market for the first time, or for those who wish to make a more conservative investment, mutual funds is the way to go.
However, the problem is not in deciding whether to invest in mutual funds, but in which mutual funds to pick.
After all, there are so many such funds on the market. A simple search engine search will give thousands of results, while advice from banks and agents will only confuse you more with more choices you can handle.
So how can you solve this problem short of going through thousands of guides and articles online, or short of listening to multiple financial advisors?
All you need to read is this one single article! Here’s we will give you guidelines that can help you pick mutual funds which shall be best for your financial goals.
So let’s get started.
You need 2 things to select a mutual fund
- You need to select the mutual fund category
- Then, you need to select the mutual fund scheme
Selecting the mutual fund category
When selecting the categories, here are the aspects you need to know.
Investment objective: This refers to your future financial goal through your investment in the mutual fund or funds. The objective can be long term or short term, and can range from retirement planning to give education for your children.
Time horizon: This refers to the time period for which you’ll be making the investment in a chosen mutual fund scheme.
It depends on your financial goal. For instance, you may want to have just an overnight investment or one of 5 years. Time horizon is important as it enables you to find suitable mutual fund schemes faster.
Additionally, it also plays a central role in managing your mutual funds. For instance, you want to have a debt fund for the short term and for the long term in ELSS. Long term investments are more stable while short-term ones tend to be more volatile.
Here are the various fund categories according to Time Horizon.
- 1-3 days- Liquid Funds
- 3 months-1 year- Ultra-short duration funds
- 1 year-3 years- Short-duration funds
- 3 years-5 years- Hybrid/Balanced funds
- 5 years- Equity funds
Risk appetite
Investors have to take into consideration their risk appetite or the risk factor. Let’s face it: investing in anything is not without risk, however small. For instance, investing or saving in the Post office has little risk, but in stocks in the stock market has a lot of risk. Mutual funds come with their own slew risks, which depend on various factors like time of investment.
From 2015, SEBI has made it imperative for mutual fund houses to inform potential investors about the risk level of each scheme. These are low, moderately low, moderate, moderate high and high. Each person’s risk appetite is different. For instance, people in their 20s have less responsibility and therefore less risk, which means they can take risky investments in the hope of getting high returns.
Selecting the most suitable mutual fund scheme
When you have determined the fund category, your purpose for investment, the time interval for investing and your risk appetite, it is now time to select the mutual fund scheme. Just follow these aspects.
Fund’s performance against benchmark index
What is a benchmark index?
It is a standard which mutual funds can compare their performance against. Announcing a fund’s performance has been made mandatory by SEBI in 2012.
Now coming back to the question of your chosen mutual fund, how is it performing? Is it outperforming the index? If yes, buy it! If not, don’t.
By the way, SEBI has made it mandatory for all mutual funds to have TRI or Total Returns Index as their benchmark index.
Performance against the category
You also need to check how well a fund is doing against others in the same category. However, the comparison should be against other funds of the same scheme type.
Unity in performance:
The best mutual fund is the one that gives you good returns. More importantly, this needs to be consistent, and this shows the fund’s commitment toward investors. For this, you need to check its historic data to determine whether the fund is giving returns on a consistent basis. An ideal mutual fund is that which maintains its performance in both bear and bull markets.
Experience of fund manager:
This is a big factor by itself. Before making a final decision, you need to check out the fund manager’s performance for the mutual fund. What you need to know is how experience the fund manager is, and whether the manager has generated any returns in the past.
AMC Track Record:
AMC or Asset Management Company is a company that manages mutual fund schemes. It decides which schemes shall be invested and thus it is essential you check whether, according to AMC, the scheme is good or not.
Assets under Management (AUM):
AUM is a total fund managed by AMC. AUM is both good and bad, as in useful and harmful. For instance, a large AUM in a small-cap fund can hinder an asset manager from entering and exiting the company as needed, and that makes it risky for an investor. On the other hand, if short-term debt and liquid debts have a large AUM, it makes it less risky.
Expense Ratio:
This is the fee charged by AMC for managing, administering, promoting and distributing various mutual funds. It includes all expenses incurred in handling these funds. If the expense ratio is low, you get more return.
