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How to Select a Mutual Fund
With their ease of investing and professional management, mutual funds are a good investment instrument to meet your financial goals. However, mutual funds vary in terms of their size, charges and past results. Once you have determined your asset allocation, how do you choose the right mutual fund scheme to invest in?
Let us look at a few important factors to keep in mind when selecting a mutual fund.
Pedigree of the fund house
When you invest in a mutual fund, you are trusting the fund house to manage your money. This is why the pedigree of the fund is important. Decisions taken by the fund house and the fund manager may have a direct impact on your investment’s performance and the realisation of your financial goals. Hence, it is important to do a check on the fund house, history of existence, track record across schemes before selecting a scheme.
Consistency in past performance
Before you choose a scheme, check how the scheme compares with others on the stated benchmarks. Do not select funds only on the basis of their performance over a 6-months to 1-year period. Instead, choose funds that have performed consistently and given steady returns over 3, 5 or 10 years by beating their benchmarks. Funds that have not just performed well when the markets are doing well, but the ones that remain steady even during a slump, are the ones to watch out for.
For example, let’s say you have to choose between two funds A and B. Fund A gives more than 80% return in the first year due to a good bull run in the market, but witnesses a sharp decline in the NAV the next year due to volatile markets. On the other hand Fund B has been giving consistent returns over a three year period. Which one would you choose?
While past performance is no measure or guarantee for future returns, a fund house giving consistent returns denotes efficient processes and sound management practices. In the above example, Fund B may be a better choice with the fund house demonstrating efficiency, risk measures and sound investment processes.
Investment strategy and objectives
You should read the scheme related documents thoroughly and understand the investment objective (which is nothing but the investment goal and the underlying rationale e.g. growth, income) of the mutual fund scheme and know the kind of securities in which your money will be invested. Evaluate the objectives and see if they are in line with your risk profile and investment goals.
Diversification
Mutual funds, by their character itself, provide diversification across stocks, sectors, and asset classes. Thus, you can use mutual funds to diversify your portfolio adequately. When you are investing in equity schemes, choose from top performing diversified equity schemes. Ensure that there is good spread of large-cap and mid-cap stocks in such schemes, and the fund has been consistent in performance for a minimum of three years. On the other hand, when you are choosing a debt fund, the first thing to do is to choose a fund that matches your investment horizon. Along with that you will have to consider the fund manager’s view on the direction of interest rates and the sensitivity of your fund towards interest rate movement. The idea of diversification is to ensure that your risks are well spread across asset classes, market sectors and the style of fund management.
Goals and their time horizon
Mutual fund schemes must be chosen carefully in accordance with one’s goals, time horizon, risk tolerance and overall financial plan. In fact, based on these parameters every investor must follow an asset allocation plan. Once you know how much you need to invest across different asset classes such as equity and debt, you must choose funds that match your tenure. If your goal is less than three years away, you should consider investing in a debt oriented fund. For a medium-term goal that is typically between 3 – 5 years, you can consider balanced funds that have exposure to both equity and debt. For long-term goals, equity mutual funds offer a good option.
Keeping the above factors in mind, you can choose a mutual fund scheme that is right for you and participate in the capital markets to reap the benefits of good returns.
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#1
Always follow an asset allocation plan before investing.
#2
Before selecting a mutual fund, check on the evaluating parameters over a 3, 5 and 10 year period.
#3
When checking the fund house history, one should also check the steadiness of the fund manager for the mutual fund scheme. A good fund house usually doesn’t suffer from too much attrition.
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