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Money makes money, is an often quoted mantra and investors are willing to do just that, aiming to fulfil their personal financial goals. However, with the number of options available at hand when it comes to mutual funds, it is very important for us, as an investor, to understand the kind of investment we want to make, and the exact mutual fund we want to invest in.
Choosing the right mutual fund is a two-step process, and we need to carefully consider multiple factors before we lock in on an option. The two factors that matter the most are our appetite for risk and the reason we’re investing in a mutual fund. Even so, it isn’t a one size fits all solution and the same mutual fund scheme is not perfect for all investors.
Considerations before choosing a mutual fund category
Let’s take a look at some of the more crucial ones now:
Investment Objective: The first, and most important thing to consider before you choose a mutual fund category, is the reason for starting the investment in the first place. The investment can be either short or long-term, depending on our financial aspiration. It can be as short as going on a vacation, or as long as the time it takes for us to retire. The mutual fund category choice we make should depend on the goal we want to achieve with it.
Time Horizon: This is the amount of time we want to keep our money invested in the mutual fund scheme. Some funds invest in shorter-dated debt periods than others. If our investment period is more than 5 years, an equity fund is likely the best option for us. For shorter terms, the market can be extremely volatile, which can be more risky, but there is always the chance of higher earnings as well.
Risk Tolerance: Tolerance or risk appetite is the limit of risk that we are willing to take against the money that is invested in the mutual fund category of our choice. As of 2015, SEBI issued a mandate for all mutual funds to carry a riskometer that indicates the risk level of a fund scheme. There are five levels of risk, namely low, moderately low, moderate, moderately high, and high. It is always best to choose a mutual fund category whose risk category matches our risk tolerance.
Measures to look at when choosing a mutual fund scheme
Now that we have discussed the considerations before choosing a mutual fund category, we should also discuss some of the attributes to look at when choosing the best mutual fund scheme for our purpose:
Performance Against Benchmark: This is a comparison of a mutual fund scheme’s performance against a standard benchmark, which is usually chosen by the mutual fund house. The investment philosophy of a mutual fund scheme can be said to be guided by its benchmark index. Asset allocations of the benchmark index should ideally be the same as the investment objective of the scheme. For example, the benchmark of a mutual fund with a banking index should be focused on banking stocks. Comparisions against this benchmark will usually reveal whether our fund itself is performing above or below expectations.
Performance Against Category: While choosing a mutual fund scheme, it is important for us to compare the performance of that fund against other mutual fund schemes in the same category. Doing this gives us a broad idea of the fund’s performance, and ensures that we have an understanding of the fund before investing. However, such comparisons should be done only across the same type of mutual fund schemes. For instance, a small-cap mutual fund should only be compared with other small-cap funds.
Performance Consistency: As already stated earlier, the market is a very volatile environment, and it is critical that we know if a fund performs consistently. Consistent returns are important to ensure that our money does not to go waste, and that we get returns during both market ups and downs.
Experience of the Fund Manager: As an investor, we should always be aware of the capabilities of the person who will be handling our finances. It is important to understand how well a mutual fund scheme is being managed by the fund manager.
Company Legacy: Mutual Fund investments should always be made in fund schemes that are brought to us by credible financial institutions. Not only does this remove any chances of fraudulent activities, but it also ensures that the fund is consistent, and that our investments are well researched. A poorly selected stock can cause losses, which is why it is imperative that we check the track record of the asset management company.
Ratio of Expenditure: While our finances are being managed under the mutual fund scheme, there are some charges that are billed to us directly. There are charges for administration, management, as well as promotions and distributions, all of which are expenses incurred during the running and maintainence of the fund, and are included in this figure. The higher the overhead expenditure, the lower our net returns from the mutual fund scheme.
Now that you know what to look for when choosing a mutual fund category or scheme, you should be able to make a more informed decision on your investments. There are a lot of other factors that can influence this decision and it’s outcomes and we always suggest that you consult your financial advisor before making any investment decisions.
