Many people opt for mutual funds as a way to increase their wealth gradually with lower risk. Mutual funds provide a convenient method to access a varied range of securities managed by skilled fund managers. Nevertheless, selecting the correct mutual fund from the wide range of choices in the market can be challenging. In this article, I will talk about the key factors to keep in mind when selecting a mutual fund for investing and give useful advice to assist you in making well-informed choices.
Mutual funds are investment funds that combine money from various investors to invest in a diversified portfolio of stocks, bonds, or other securities. Professional fund managers handle these funds and make investment choices for the investors. Mutual funds provide benefits such as diversification, professional management, and liquidity.
Factors to Consider When Selecting a Mutual Fund
Here are some key factors that you need to keep an eye out for selecting a good mutual fund.
#1 Investment Objective of Fund
The investment objective will explain the scope of investment. Whether the fund is equity or debt-oriented, whether the fund will be multi-cap, large-cap, mid- or small-cap specific, the level of diversification. You should relate whether your objective of investment matches your investment objective or not, this also depends on your risk-taking capability if you are worried about capital protection only you can opt for a debt fund else you may think of large-cap,multi-cap funds.
#2 Type of fund
Another thing you must check is the type of funds, Is the fund open-ended or close-ended? You can sell open-ended funds at any time while the closed-end fund has a lock-in period you cannot sell till the lock-in period is over. If your investment planning is short term you should not select close-ended funds. Another thing you must check is fund is a growth fund or a dividend. Dividend funds provide you dividends at every year from profit usually dividend fund NAV is lower compared to Growth funds.
#3 Fund Manager
You must inquire about the fund manager who is managing the fund. You must analyze the qualifications and experience of the fund manager. Ultimately fund manager makes the fund healthy. Most of the fund-related information will be available in offer documents or fact sheets.
#4 Asset Allocation / Stock Holding
One should know asset allocation details and stock holding in various sectors. This is a very important factor as the return on your investment totally depends on where your money is invested.
Asset allocation and stock holding cause the classification of funds into small-cap, mid-cap, multi-cap, large-cap, blue-chip, debt fund, etc. You should compare your risk profile with this fund and make a selection based on that. If you have a low-risk profile and seeking regular income you may select a debt fund someone with an aggressive profile may go for multi-cap small-cap, or mid-cap funds. Those who are looking for stability in profile may go for large-cap funds.
Mutual Fund Tax – How to Calculate Tax on the Mutual Funds?
#5 Investment Method
This section provides guidelines about the Minimum initial investment required, methods of purchasing, redeeming, and making additional investments, the time taken for redemption, so forth, and so on.
One should always select a SIP plan instead of doing a one-time investment as a regular investment at regular intervals provides stability to profile & divide risk.
#6 Exit Load
Fees, expenses and loads are other big items to look out for. Many funds in market charges entry load or exit load you should consider this cost (percentage of load) before making investment.
#7 Past Performance Appraisal
The task of wealth creation with mutual funds is like Test cricket where a rapid hundred or several super six does not always help you in winning the game. You need the consistent performance of Sachin Tendulkar, rigidity on the pitch like Yuvraj, and a captain like Mahendra Singh Dhoni to fulfill your target.
Some mutual fund schemes gives very high returns in very short time, but may be dangerous for investment, you should at least consider past 5 year performance before making any investment.
Many websites provide you with this information quite handy for analysis. Some people also do appraisals on the past three years it depends on person to person.
#8 Standard Deviation
One very important factor that many people miss is the standard deviation of Mutual Funds. Standard deviation measures the volatility of the returns from a mutual fund scheme over a particular period.
This provides you an indication of how much the fund return can vary from the historical mean return of the scheme. If a fund has a 10% average rate of return and a standard deviation of 4%, its return will range from 6-14%.
#9 Expense Ratio
The ratio is the annual expenses incurred by the funds expressed in percentage of their average net asset. To make the choice between two similar funds, you should consider the expenses charged by them. Lower expenses (ratio) benefit you in the longer term. With growth in fund size fixed expense associated with this funds get spread out with large number of investor causing reduction in expense and leaving more funds for investment.
Hence if you are making an initial investment you should look for a large fund where the expense ratio is lower.
#10 Sharpe Ratio
This measures how well the fund has performed vis-a vis the risk taken by it. The higher the Sharpe Ratio, the better the fund has performed in proportion to the risk taken by it. One should look for fund with higher Sharpe ratio.
#11 Alpha, Beta
Alpha is the excess return of a fund compared to its benchmark index. If a fund has an alpha of 5%, it means it has outperformed its benchmark by 5% during a specified period.
Beta measures a fund’s volatility compared to the benchmark. It tells you how much a fund’s performance would vary compared to a benchmark.
A fund with a beta very close to 1 means the fund’s performance closely matches the index or benchmark. A beta greater than 1 indicates greater volatility than the overall market, and a beta less than 1 indicates less volatility than the benchmark.
Aggressive investors may choose funds showing high betas which increase the chance of beating the market and earning good returns. Low-risk investors are advised to select funds with a beta less than one less volatile.
#12 Rating of Mutual Fund
Many people rate mutual funds, as an additional precautionary measure you may consider the rating of a fund before making investment but you should not invest only on the basis of Rating.
Apart from the above, you must look at how these funds fit into the rest of your holdings and how your overall Mutual funds portfolio behaves.
The last but very important point is to start as early as possible; invest as much as you can; Avoid redemption as long as possible!
Selecting Mutual Funds for Different Financial Goals
Various financial objectives may necessitate various categories of mutual funds. When planning for retirement, think about putting your money into diverse stocks funds that focus on long-term growth. Choose less risky debt funds or money market funds for short-term goals like saving for education or buying a car. Thematic funds are ideal for investors who want to take advantage of particular trends or industries, like technology or healthcare.
Best Practices for Investing in Mutual Funds
Follow these best practices to make the most of your mutual fund investments:
- Avoid emotional decision-making: Stick to your investment plan and avoid making impulsive decisions based on short-term market fluctuations.
- Consistently invest over time: Take advantage of dollar-cost averaging by investing a fixed amount regularly, regardless of market conditions.
- Seek professional advice when needed: Consult with a financial advisor or investment professional to get personalized guidance and advice tailored to your specific situation.
Conclusion
In conclusion, selecting a good mutual fund for investment requires careful consideration of various factors, including investment objectives, risk tolerance, fund type, expenses, performance, and tax implications. By conducting thorough research, diversifying your portfolio, and staying disciplined in your investment approach, you can build a successful mutual fund portfolio that helps you achieve your financial goals.
Disclaimer: Mutual Fund Investments are subject to market risks. Please read the Scheme Information Documents and Statement of Additional Information (SID & SAI) carefully before investing.
