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How to select a Mutual Fund and evaluate its performance?

Created on 28 Apr 2022

Wraps up in 6 Min

Read by 5.6k people

Updated on 03 Oct 2023

Is there a point? You're going to choose the one with the highest trailing returns anyway. Aren't you?

“Mutual fund investments are subject to market risks; read all scheme-related documents carefully”  I'm sure a lot of you might read it as if you are rapping because that's how it was done in TV commercials. 

Yes, mutual funds are related to market risk, but along with this, you must also have heard “Mutual funds Sahi hai”, and trust us, you can rely on both statements. Today, we will dedicate all our time to mutual funds with this article. 

We will see why financial planning is essential before investing and the various ways by which you can evaluate the fund you want to invest in. So, let’s get started. 

Financial Goal Planning

Financial goal planning is like sowing the seed of a tree. It is the first step to attaining your financial goals. 

Your mutual fund's investment needs to be aligned with your financial goals. For example, if you are saving for your retirement, then short-term liquid funds are not your option. But if you are thinking about investing for, say, just 6 months, then this type of fund can be your ideal choice. 

Your financial goals can be for major future purchases, such as a house, car or a family trip, or they can be for risk management, such as an emergency fund. It can also be your retirement needs and so much more. 

You have to list these goals and also categorise them based on the time frame, such as short-term (up to 1 year), medium-term goals (from 1 to 5 years), or long-term goals (more than 5 years).

Talking about mutual funds, you have to choose the right kind of fund that matches your risk profile & investment objective. Below are some of the guidelines you can consider for your investment and goal-planning aspects.

Now, without waiting any further, let’s dive in to take a look at the key factors you have to keep in mind while evaluating a mutual fund.

Key factors to keep in mind while evaluating a Mutual Fund

Any and all investors are advised to properly research before engaging their funds in any instrument. Mutual funds are no different. If you need to conduct a proper financial study before investing in the shares of a single company, you definitely need to conduct some for a mutual fund (it's a collection of shares and sometimes other instruments, after all). Here are a few aspects of a fund you need to consider before investing:

Expense Ratio

It is the total percent of funds used as operating expenses such as administrative, advertising and others.

For example, if the expense ratio is 0.5%, that means out of the total assets the fund house is managing, 0.5% will be paid to cover all the expenses. 

So basically, the expense ratio is like the annual maintenance charge for investing in a mutual fund. In a nutshell, the components of the expense ratio are management fees, 12B-1 fees, maintenance expenses, entry and exit load, brokerage fees etc.

The expense ratio is usually deducted from the returns generated from the fund. The higher the expense ratio, the higher will be the deduction from your total returns. Thus, it is essential to take a look at the expense ratio. The lower, the better.

Expense ratio= Total expenses incurred / Total AUM

Portfolio Turnover ratio

It is the rate at which the assets in the fund are bought and sold by the fund managers. It is nothing but the indication of the frequency at which the holdings in the portfolio are replaced in a year. 

This ratio basically defines the strategy of the fund manager. A higher ratio indicates more transactions which will increase the overall expenses in the fund, reducing the returns to the investor. 

A high PTR indicates that the fund manager is following a trading strategy, while a low PTR suggests that the fund manager is following a hold strategy. 

PTR= Minimum securities bought and sold/Average Net assets * 100

Minimum securities bought and sold” considers new securities bought over the year or total securities sold over the year. The lesser of the two amounts is selected in the calculation.

Average Net Assets” means the monthly average value of assets held over the last year by the fund.

Exit Load

The exit load is the fee that the AMC charges the investors when redeeming the funds.  It may be referred to as the fees or penalty the asset management company charges for exiting the fund. So obviously, the charge is levied to discourage investors from exiting the fund. 

Thus, investors are advised to take a look at the percentage of exit load you will have to pay for exiting the fund. 

The reputation of the fund house and fund manager

The performance of the funds is highly dependent on the fund house and fund manager. When choosing the fund house, a well-known track record is vital, one which has handled various market cycles and one that has proven its performance in the past. 

Along with the reputation of the fund house, the fund manager's reputation is equally important. The track record of the fund manager will give you an idea about the strategy, skills and experience in the market. 

Keep these factors in mind before analysing a fund manager:

  • Compare the returns of the fund you want to the returns of other funds managed by him. 
  • How consistent he has been. 
  • His investment and risk management strategies. You can find this information through interviews & other media on the manager. 

Asset Under Management

AUM or asset under management is the total value of assets or funds, such as cash, bonds, equities, real estate and more, that a mutual fund company manages on behalf of its investors at a given point in time. 

The amount of assets a company manages acts as a USP for mutual fund houses. This is why this figure is often used as a marketing tool. An investor should look at the number of funds a company handles because a fund with a high AUM is more liquid, making the exit process easier for investors and vice versa.

Conclusion

These are just a few simple steps before investing in a mutual fund. But there is a lot more to the selection process. There are various steps you can take to get better at it, and Quest by Finology is one of those steps. 

 

Quest is your ticket to financial freedom. It is a learning platform by Finology that offers you a variety of courses related to finance and investing. Quest will make you financially aware and help you take the process of wealth creation into your own hands. 

Get ready to learn about Mutual Funds with Quest and its Marathon course, A Complete Guide on Mutual Funds. Where you will learn everything starting from savings and investing to taxation of various types of mutual funds. What’s more, the course is a part of BSE institute certification.

That was all for today; until then, Happy Learning! :)

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Ayushi Upadhyay

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A Keen Learner. Tiny, brainy, and studious, this quiet one stays in her zone until she pops. And once she does, boy, are her comebacks snappy! There is no financial question that she can't answer through her magical blog-writing. 

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