How to Pick the Best Mutual Fund?
Mutual funds are the most preferred option for investors when it comes to investing. They are regarded as safe investments with high returns. Mutual funds are a type of investment scheme that accumulates multiple investors’ funds to create an investment product. They are managed by professionals, known as a fund manager. Fund managers then invest that collected money into various financial instruments such as equity, bonds, gold, etc.
With so many different types of mutual funds, fund houses, and schemes to choose from, many investors find it difficult to select a mutual fund. You must look through the various schemes available, pick the best one, and deposit your money. Here are some factors that you should look for while selecting a mutual fund as per your needs:
Some factors to look for while selecting the best mutual funds
1. Identify your investing goals:
With so many popular mutual fund schemes available, selecting the best one depends on your goals. While investing, you should be clear with your objectives and your targets. For example, do you want your money to grow steadily over time while remaining safe? For how long do you want to stay invested? You will have to answer these questions for yourself.
Your goals can be split into two categories: short-term and long-term. A short-term goal can be an international tour, any upcoming down payment, etc. While long-term goals can be buying a house, retirement planning, or education for your children.
You must choose a mutual fund scheme based on the answers to these questions. It can be an equity fund, a debt fund, or a mix of both, which is known as a hybrid fund.
2. Determine your risk tolerance:
We all know that the more risk we can take, the higher returns we expect. Mutual funds also involve some level of risk. So, you need to consider your risk tolerance and invest accordingly. First, decide, are you the conservative one? Or an aggressive investor, who can take a good amount of risk?
For example, equity mutual funds carry a higher level of risk, so you may experience ups and downs in your portfolio in short term. However, the returns on equity mutual funds are frequently higher than those on other funds. On the other hand, debt mutual funds are less risky and more stable, but their returns are lower than those of equity mutual funds, making them ideal for conservative investors and beginners.
The table below lists the fund categories that are best suited to various risk levels and time horizons:
|Time Horizon||Low risk||Medium risk||High risk|
|Short-term (up to 3 years)||Liquid Funds, Ultra Short-duration Funds,|
|Short-duration Funds||Arbitrage Funds, credit risk funds|
|Medium-term (3 years-5 years)||Short-duration Funds, Gilt funds||Balanced Advantage Funds||Equity Hybrid Funds|
|Long-term (More than 5 years)||Large Cap Funds||Multicap Funds||Mid Cap Funds, Small Cap Funds|
3. Check the Expense Ratio and Entry or Exit Load:
The expense ratio is the commission charged to manage the investments properly. It is essentially the fund manager’s fee, which is levied on all investors in order to ensure profits across all investments. As an investor, you should seek out mutual funds with lower expense ratios. A higher fee means less income. It is because, while the percentage may appear small when calculated across your entire investment portfolio, it has a greater impact. The fee can range between 0.50% and 3%.
Some funds charge entry load fees when you buy shares, while others charge exit load fees when you sell them. However, in India, the entry load charges in mutual funds are banned. As an investor, you should look for mutual fund schemes with no or low entry and exit loads.
4. Understand the fund’s management style:
Every fund manager has a unique way of working or operating that eventually becomes the fund’s style. Now, there can be different styles that you should evaluate. For example, Active versus passive styles, Aggressive versus conservative style, Value versus growth style, etc.
Active fund management necessitates frequent buying and selling of stocks to outperform a specific benchmark or index. While in passive fund management, fund managers just replicate the index or benchmark performance. The primary goal of passive investment management is to generate returns similar to a benchmark index. The index fund is a common example of a passive fund. Actively managed investment portfolios are more expensive because it involves continual buying and selling which in turn requires more time from the fund managers. However, in the case of a passive fund, the cost charged is not very high. However, the returns are restricted to the benchmark.
The other type or style is growth or value funds. Growth funds aim for capital appreciation and also, and they do not have any dividend payments. However, in the case of value funds, they invest in undervalued stocks with high dividend yields.
5. Evaluate fund performance:
Before investing your hard-earned money into mutual funds, you should assess the quality of the funds and check their past performance. It is essential to research the fund’s past performance and check if they have been able to beat its benchmark over the period of three, five, or ten years. Choose funds that have consistently delivered steady returns in the long run.
Every mutual fund manager experiences a period of underperformance in comparison to their benchmark. So, you should check the performance in multiple periods to assess how the fund manager has performed in different market environments.
Apart from this, you should also study the fund manager’s experience and their team. Investors would benefit from a strong, stable, and experienced Fund management team with a reasonable tenure and a proven track record of performance.
6. Consider the total Fund Size:
Another metric that you should look for is the total assets invested in the fund. Sometimes, a fund becomes so large, that it becomes difficult to maintain a fund manager. To accommodate the significant daily investment inflows, fund manager tries to change their investment strategy. Due to this, the performance of the fund suffers.
Smaller funds are also riskier because, like smaller businesses, they are more likely to be closed down. To be profitable, funds must grow to a certain size. So, there is no specific rule for a fund size or the asset under management. You should look for various factors before investing.
7. Consider the taxes attracted by your investment:
Tax consideration is another factor that you must always consider. When you make money/returns from your investment, it is taxable under the Income Tax Act. There is different taxability structure for equity funds and debt funds.
Equity funds if held for more than one year are taxed under Long-term capital gain (LTCG) at the rate of 10% without indexation. Gains of up to ₹ 1 lakh are exempted from tax. Equity funds held for less than a year are subject to Short Term Capital Gains (STCG) taxation. The STCG tax rate is 15%.
Debt funds held for more than three years are subject to Long-Term Capital Gains taxation. The current LTCG tax rate is 20% plus indexation. Debt funds held for less than three years are subject to Short Term Capital Gains taxation. STCG for debt mutual funds is taxed based on the individual’s tax bracket.
Where Should You Invest – Regular or Direct?
A mutual fund scheme is divided into two types of plans: direct and regular. A regular scheme is one in which you invest through a registered broker or mutual fund agent, and they charge you a certain fee or commission. In contrast, in the direct scheme, you invest directly with an Asset Management Company (AMC) or mutual fund. In a direct plan, there is no such fee or commission.
A significant difference between the two is that direct Mutual Fund returns are slightly higher because no commission expenses are incurred. They are managed by the same fund manager and invest in the same stocks and bonds.
A direct mutual fund is best suited for an investment-savvy investor who has the market knowledge, expertise, and time to determine the best mutual fund to invest in. While the majority of investors require investment advice. Those seeking such guidance can invest in the best funds recommended by their advisor. The money is then invested in a regular plan.
The Bottom Line
Investing may look intimidating in the initial days, especially with all the jargon floating around. But, once you get a habit of investing, it becomes an easier task. Keep an eye on your money on a regular basis. Your work does not end with putting money into the fund. When you receive the fund fact sheet each month, review the fund manager commentary, the actual returns, the portfolio mix, and so on. They can provide you with valuable information. Just remember to stay disciplined, and rational, and avoid being swayed by short-term market price movements. Your long-term goal is to accumulate wealth.