Are you thinking about investing in a mutual fund scheme? But aren’t sure which scheme is the most appropriate based on your goals? Don’t worry; you are not alone!
Finding the right fund amid hundreds of offers can be confounding. Any wrong choice will make you lose big money. So, how can you select the right mutual fund scheme and pass on the saying “Mutual Funds Sahi Hai” to your friends?
To achieve this objective, as an investor, you need to first identify your investment objective, the time horizon of investment and risk appetite. Having a fair idea of this will allow you to arrive at a mature investment plan.
Here are some must-remember parameters which will make the selection process more comfortable:
Know the risk-return trade-off
A good mutual fund is one which gives better returns than others for the same type of risk taken. If returns are not in proportion to the risks taken, it is not worth going for such a mutual fund scheme.
One of the indicators of risk-adjusted return is Sharpe ratio. This ratio is calculated by taking the excess return given by the fund over return given by a risk-free instrument divided by standard deviation.
Tip: Higher the Sharpe ratio, the better the risk-adjusted return is!
Research the fund’s performance
Gauge the returns given by the fund during different time periods and compare them with the benchmark index or other funds in the same category. Avoid funds whose returns are volatile, instead look for consistency and long track record.
Tip: For equity mutual funds, check three-five years performance, whereas for debt mutual funds check the returns over the short to medium term.
Look for portfolio diversification
Check the portfolio history of a particular scheme and see if the fund has been historically maintaining a well-diversified portfolio. Look at the monthly portfolio of a scheme on the fund house’s website.
Tip: Know if the scheme is providing adequate diversification across different asset classes, stocks, sectors in order to lower the risk level.
Know the Asset Under Management
Net assets of any scheme give a fair idea of the mutual fund scheme. You can cross-out mutual fund schemes with below average AUM. Less Asset Under Management in any scheme is very risky as you don’t know who the investors are. So, the exit of any big investor may impact the overall performance of such fund very badly.
Tip: Fund houses deploy their best fund managers for mutual fund schemes with high Asset Under Management.
Know the fund house
The fund house is responsible for managing our money and thus take us closer to our goals and secure our future. If the fund house fails in its objective, the money will be lost. Research the fund house with respect to its:
- Investment approach
- Types of schemes offered
- If it is offering the same type of funds under different names
It also becomes essential to know all kinds of fees that you may face when purchasing a mutual fund scheme.
Tip: Although this information is available in the scheme information document, question either the fund house or its representative to get more detailed information.
Check the ‘Expense Ratio’
The expense ratio is the annual expenses incurred by the fund and is expressed in percentage of their average net asset. As the funds grow in size, the fixed costs associated with the fund get distributed amongst the investors, thus reducing the expenses.
Expense ratio drops till the asset reaches a certain threshold after which the expenses are typically stagnant.
Tip: To choose between two similar funds, check their expense ratio. Know that schemes with higher assets may have lower expense ratio than that of a small sized fund.
If invested carefully, mutual funds are a great tool for long-term wealth creation and the saying “Mutual Funds Sahi Hai” remains true. However, it is vital to understand that investments in mutual funds are subjected to market risk. Timings play very crucial role in your returns, so study the scheme before investing.
Choosing the mutual fund may seem like a daunting task, but if you know your objectives and risk tolerance, then half the battle is won. If you analyse a particular scheme with the check-points mentioned above, you can minimise your risk by following a proper selection process.
The quote “Mutual Funds Sahi Hai”, will reap benefits when you do your research thoroughly. Happy Investing!