How to choose a Mutual Fund?

Mutual funds are a preferred choice among people to enter the stock market. Now, if you are looking for an investment, you will find that there are thousands of mutual funds out there in the market. If you will take advice from agents or banks, they will tell you that all the policies are good. If you will Google or Bing it, you will find thousands of lengthy articles saying a lot of different stuff about different mutual funds.

But now, if you are among those who do not want to study big lengthy articles and make things complicated, this read can solve your problem.

We will give guidelines through which you can shortlist different mutual funds and choose the best one for you and your financial goals.

So, let us now get into the crux of the matter

Selecting a mutual fund involves two things

1. First, you have to select the mutual fund category. 

2. After that, you have to select the best mutual fund scheme.

Selecting the mutual fund category 

Aspects you need to keep in mind before selecting the mutual fund category are: 

Investment Objective

An investment objective means the future financial goal of the investor through the investment in a mutual fund. The objective can vary from short term to long term, from retirement planning to funding education for children.

Time Horizon

Time Horizon means the period for which an investor wants to be invested in a mutual fund scheme. Time horizon varies for every financial goal, from being invested overnight to more than five years. It plays an important role for you as you can filter out your search for mutual fund schemes through it.

Time horizon also plays a role in smart managing your mutual fund portfolio. For instance, you want to be invested in a debt fund for the short term and long term in ELSS. Short term investment can be volatile, but the long-term investment will mostly be stable. 

The following table will help you understand fund categories for a different time interval:

Risk Appetite

Risk is also one of the important categories investors keep in mind before making any investment. Since 2015, SEBI has made it mandatory for mutual fund houses to display a riskometer for every scheme they are presenting in the market. The riskometer shows five distinct levels of risk, which are – low, moderately low, moderate, moderately high, and high. Low is the lowest level of risk and subsequently moderately till high, which is the maximum risk.

Every individual has a different risk appetite. A younger person will have less responsibility and can bear the risk, and so this young person takes a risky investment in the hope of high returns. On the other hand, an older person will take up less risky investments.

The following table shows the fund categories in a different period with different risk appetite:

Selecting the best mutual fund scheme

After selecting the mutual fund categories and deciding your investment purpose, the time interval of investment, and risk appetite, you can now select a mutual fund scheme within your desired category simply by checking these aspects.

Performance Against Benchmark

A benchmark is a standard through which mutual funds compare against their fund to ascertain the performance of that fund. Since 2012, SEBI has made it mandatory for mutual funds houses to announce a benchmark index. 

So, in layman's terms, what you do in this is that you compare the performance of a particular scheme with the benchmark index. For instance, if you have invested in a mutual fund that invests your money in companies with big market capitalization, then you will check the benchmark of large-cap stocks.

If the scheme is outperforming the benchmark index, then it is a favourable mutual otherwise, it is not. 

SEBI has also made it mandatory for mutual funds to use the Total Returns Index (TRI) as their benchmark. 

Performance Against Category

Investors will also need to check the performance of a particular fund in comparison with their peers. This gives the investor a complete knowledge of the performance of that fund.  

But keep in mind that you will compare a scheme with the same type of scheme only. 

For instance, for a mid-cap fund, you will compare the performance of that fund with other mid-cap funds only; you cannot compare that fund with a large-cap fund, as that will not give a holistic picture.

Uniformity in Performance

An ideal mutual fund is the one that always generates a good return for its investors. Consistency in good returns shows the commitment of that fund towards its investors. So, you should check 5-10 years of data to ascertain the fact whether the fund is generating returns consistently or not. An ideal fund will maintain its consistency in both the bull and bear market.

Fund Manager's Experience

While selecting a fund, you will also check the past performance of the fund manager of the mutual fund. You will check whether that person is experienced or not, whether that fund manager has generated a return in the past or not. You will not like to invest in a fund with a fund manager who has no experience or who has a bad record of accomplishment. 

AMC Track Record  

An Asset Management Company (AMC) is a company that manages mutual fund schemes. For instance, Kotak Mutual Fund is the name of the AMC which manages schemes like Kotak Asset Allocator Fund, Kotak Classic Contra or Kotak Dynamic Bond Fund. AMC decides the stock in which schemes will be invested, so it becomes important to check whether the track record of that AMC different schemes is good or not.

Assets Under Management (AUM)

The Assets Under Management (AUM) is the total fund managed by the AMC. AUM is both useful and harmful. A large AUM in small-cap funds can hinder the Asset manager from timely enter or exit the company as per need, so it makes it quite risky for an investor. On the other hand, a large AUM in liquid and short-term debt makes it less exposed to redemptions.

Expense Ratio

Expense Ratio represents the fee charged by AMC for administering, managing, promoting, and distributing different mutual fund. The expense ratio includes all the expenses incurred by the AMC in handling the funds. SEBI has put a limit on the Expense ratio of 2.25% of the total fund asset. If the expense ratio is low, the investor will get more return and vice versa.  

The Bottom Line

You can review a mutual fund according to your financial goal by following the above-mentioned aspects.

In such a huge market with many funds, you get confused and rely on your friends or agent's advice for selecting a mutual fund investment. 

The above-mentioned aspects are extremely easy to interpret. So, select the fund which is the best for you and your financial goals.