Right Mutual fund selection today has become as though as winning cricket world cup. As per statistic total 190 fund houses has around 7147 Mutual funds schemes for Indian investors.
This numbers make mutual fund selection task more difficult. Market risk is involved while purchasing mutual funds hence you must be careful while selecting mutual funds.
Many times I hear from many investors that how do we select a mutual fund? It is very difficult to make selection. This inspires me to write small article which will provide you correct guidance in making selection of good mutual fund.
You must have following information before starting your journey for selection of mutual funds.
Financial goal for investment
Fund selection without having an investment goal is useless. You should know reason of investing in mutual funds.
Apart from investment purpose you must know how long you stay invested in this mutual fund & at what stage you redeem (sell). Your investment will be short term (1 to 2 years) or Long term investment (5 to 10 years).
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Here are some key factors that you need to keep an eye out for selecting good mutual fund.
(1) Investment Objective of Fund:
This 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 that your objective of investment is matching with investment objective or not, this also depend on your risk taking capability if you are worried about capital protection only you can opt for debt fund else you may think of large cap ,multi-cap funds.
(2) Type of fund:
Another thing you must check is type of funds, Is the fund is open- ended or close-ended? You can sell open ended fund any time while close-end fund has lock-in period you cannot sell till 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 growth fund or dividend. Dividend funds provides you dividend at every year from profit usually dividend fund NAV is lower compare to Growth funds.
(3) Fund Manager:
You must inquire about fund manager who is managing fund. You must do analysis about qualification and past experience of fund manager. Ultimately fund manager makes fund healthy. Most of fund related information will be available in offer document or fact sheet.
(4) Asset allocation / Stock Holding :
One should know asset allocation details and stock holding in various sectors. This is very important factor as return on your investment totally depends on where your money is invested.
Asset allocation and stock holding cause classification of fund in to small cap, mid cap, multi cap, large cap, blue chip, debt fund etc. You should compare your risk profile with this fund and make selection based on that. If you have low risk profile and seeking regular income you may select debt fund someone with aggressive profile may go for multi cap or small cap, mid-cap funds. Ones who are looking for stability in profile may go for large cap funds.
(5) Investment Method :
This section provide guideline about 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 SIP plan instead of doing one time investment as regular investment at regular interval provide stability to profile & divide risk.
(6) Cost :
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 :
Task of wealth creation with mutual funds is like Test cricket where rapid hundred or several super six not always help you in winning game. You need consistent performance of Sachin Tendulkar, rigidity on pitch like Yuvraj and captain like Mahendrasingh 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 website provide you this information quite handy for analysis. Some people also does appraisal on past three year it depends on person to person.
(8) Standard Deviation :
One very important factor which many people miss is standard deviation of Mutual Fund. Standard deviation measures the volatility of the returns from a mutual fund scheme over a particular period.
This provides you indication that how much the fund return can varies from 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 initial investment you should look for large fund where 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 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 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 investor may choose funds showing high betas which increase chance of beating market and earning good returns. Low risk investors are advice to select fund with beta less than one less volatile.
(12) Rating of Mutual Fund :
Many people rates mutual funds, as an additional precaution measure you may consider rating of fund before making investment but you should not invest only on basis of Rating.
Apart from above you must look at how these funds are fitting in rest of your holding and how your overall Mutual funds portfolio behaves.
Last but very important point is start as early as possible; invest as much as you can; Avoid redemption as long as possible!
Hope this article will help you in selecting or making good mutual fund portfolio. Please drop in your question/suggestion in comment section if you have any.
You can check Mutual Fund Fact sheet here.
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.