Mutual funds (MFs) were created decades ago, when it was harder for the individual investor to diversify their investments. MFs are “one size fits all” investments – pooled investments where everyone gets a slice of the pie. You don’t have any control over the underlying holdings, and you might not even know what the holdings are until months after joining the fund.
Any investment decision needs a thorough study and the same holds true when it comes to investing in MF.
Here are the six ways which will help an individual zero in on the right mutual fund.
Have an investment goal: The first step is to have an investment goal. “Why are you investing? Are you investing to substitute your current income or planning for retirement, children’s education, anyone’s marriage or children’s marriage? These are the questions you should ask yourself. You should define your expectations in terms of time horizon, returns and risk.
Defining each of these parameters would help you choose the asset class you are going to invest in. For example, if you have an investment horizon of five to seven years, you can invest in an equity scheme. If you have investment horizon of less than three years, then debt-bond fund, short-term fund could be a better option. If you have near to medium-term goals, you would be better off in comparatively safer debt schemes. If person can take above average risk, then credit opportunities fund could be a good option.
Assess your risk appetite: MFs are market-linked products thereby susceptible to market risks. The returns are not guaranteed. So, before choosing a scheme it is important to understand if it matches your investment objectives/ goals and risk appetite. Equity funds are high-risk, high-returns products while debt funds are at the other end of the spectrum. Choose the MF product which suits your investment objective and risk appetite.
Analyse the performance of different MFs: Look and compare different MFs on the basis of their past performance and investment philosophy. If you are using a MF portal to assess the ranking of the mutual funds then also under the ranking methodology. Always look for consistency over outperformances during different phases in the market. You can also do some number crunching yourself and not solely rely on MF-research agencies. There are risk-return indicators available which can help you to judge the performance of the mutual fund. Alpha is one such indicator; it is a measure of a mutual fund’s performance on a risk-adjusted basis and as compared to the benchmark. A positive alpha indicates that the fund is doing well. Beta is the measure of a fund’s volatility as against the benchmark. It measures the fund’s sensitivity to changes in the market. For an investor with low risk appetite, a fund which has a beta value less than one is the right choice and the opposite is true for those willing to have a higher risk appetite.
Do proper research: Research on the fund house that is promoting it and has a strong global or domestic track record in asset management. The longer the fund has been in business, the better it is. Also understand the investment strategy of the fund manager. A fund manager decides on instruments or securities to invest in. Being pre-emptive and not reactive is what distinguishes a good fund manager from an average one. Look at how he has managed the scheme of your choice over a medium to long period. If the fund manager has taken over the fund very recently, it would be a good idea to give him some time to prove his worth. For this, you should refer to the shareholder reports and prospectuses provided by AMCs.
Exit load: Exit load is paid by the investor when he redeems the investment before a certain period. Different types of funds have different exit loads depending upon the nature of assets held by them. It is important to check exit load of the mutual fund scheme as you might need money before investment horizon. Try to invest in schemes with minimal exit-load requirement.
Expense ratio: There are ratios that would further help you to eliminate some more schemes from your shortlist. Total expense ratio is one of the main ratios. It is a measure of the total cost to the investor. It takes care of the fund manager’s fee, administration and other operational expenses. While calculating returns from the scheme, it is advisable to check the total expense ratio as it eats into returns from the scheme.
The writer is chief investment officer, LIC Mutual Fund
Source: dnaindia.com