Mutual funds are a preferred choice among investors today owing to their attractive returns and diversified portfolio. However, as an investor one must remember that no single scheme or set of schemes is suitable for everyone. A suitable mutual fund scheme for an investor is the one which suits his/her investment objective and risk appetite among other factors.
Moreover, mutual fund investing is a long-term relationship. Unlike the direct investment in stocks, where the people can switch the stocks fast, mutual funds are a long time period commitment. Most people stick with their funds for over 8-10 years. Therefore, it’s important that you choose a right fund and not get stuck with lagging ones which might result in you to lose both time and money.
Selecting a mutual fund is a 2-step process – selection of the mutual fund category and selection of a scheme in that category.
Here are the 7 easy Steps which an investor should consider How to Select Right Mutual Funds that will help you to meet your investment goals :
Table of Contents
1. Read the Mutual Fund Offer Document Carefully
The Scheme Information Document consists of important information regarding the scheme such as the investment objective, the pattern of asset allocation, risk involved, investment approach, fund manager, benchmark index, fees and expenses, etc. The Statement of Additional Information, on the other hand, carries all statutory information of the mutual fund house.
The preparation of both the SID and SAI are done in the format prescribed by the Securities and Exchange Board of India (SEBI) and they have to be submitted to SEBI. The fund house can also include any disclosures that it feels is necessary for the investor.
How to read the Mutual Fund Offer Documents?
Since the SID contains important details of the scheme, it is imperative to go through it thoroughly. While doing so, ensure that you read the below-mentioned points in the SID:
Investment objective – This section explains the intent behind the launch of a scheme and how it will be achieved. The investment objective clarifies the doubt investors may have concerning the names of the schemes. For instance, ‘Capital Protection Oriented Funds’ may not guarantee protection of capital and hence, the investment objective clears such ambiguities.
Asset Allocation – This section indicates how the scheme will allot its assets to the relevant asset classes (such as debt, equity, and gold) under usual market conditions. The pattern of asset allocation indicates the range of the maximum and minimum exposure to the various asset classes. Investors can judge if a scheme is debt-oriented, equity-oriented, commodity-oriented, etc., from the asset allocation and give them an idea whether the scheme fits their investment requirements or not.
Investment strategy – This section explains the approach or style the fund house will follow while choosing the securities to invest in. This is vital because the investment strategy is a reflection of the systems and processes the fund house follows. Fund houses with a clear investment strategy impart a sense of confidence in the minds of investors.
Benchmark of the scheme – A benchmark is chosen for a particular mutual fund scheme so as to structure the scheme according to the constituents of the benchmark.
Risk factors – Mutual funds carry certain risks with them which can hamper the valuation of the investments. Investors should be aware of the various types of risks that the scheme carries so that they can evaluate if they can tolerate the risks for the achievement of capital appreciation.
Fund manager – The expertise of the fund manager is crucial for the scheme’s overall performance in the long run. A few of the qualities that you should look for in the fund manager are the experience, qualification, track record, etc. This information can be found highlighted in the SID.
Past performance – Though the past performance of a fund cannot guarantee its future performance, it can be used to guide your investment decision. The SID of an existing mutual fund scheme will bear the scheme’s past performance over different time frames. This information can be used to assess if the track record clocked by a particular fund fulfils the investment objective of the fund.
Fees and expenses – The expenses charged by the AMC are directly proportional to the net returns delivered by a particular scheme. In the process of fetching optimal returns for the investor, the AMC will levy charges in the form of loads, fund management fees, switching charges, etc. These charges are deducted from the NAV of the scheme and hence, as an investor you should look for a scheme that has a lower expense ratio which would translate to you achieving higher capital gains.
Investment options – Most mutual fund schemes offer 2 options of investment – growth and dividend. The dividend option further offers a payout and reinvestment option. Also, there are various modes of investing such as the SIP (Systematic Investment Plan), lump-sum investment, and STP (Systematic Transfer Plan). Remember to read through the SID to look for these options so that you can make an informed decision based on your investment needs.
These are some of the important aspects of a mutual fund scheme that will be mentioned in the SID and which you need to look out for. Reading the SID thoroughly will help you judge the credibility of the AMC and the scheme in which you are planning to invest your hard-earned money on.
2. Match the Objective of the Mutual Fund with your Objective
Investment objective refers to an investor’s financial goal which he/she aims to accomplish with the mutual fund investment. The investment objective can be any short-term or long-term financial aspiration of the investor – buying a house/car, financing children’s higher education, going on a vacation, retirement, etc.
Just as you would buy a computer that fits your needs and budget, you should choose a mutual fund that meets your risk tolerance (need) and your risk capacity (budget) levels (i.e. has similar investment objectives as your own). Typical investment objectives of mutual funds include fixed income or equity, general equity or sector-focused, high risk or low risk, blue-chips or turnarounds, long-term or short-term liquidity focus.
You need to read the offer document of the fund and attentively identify whether the fund objectives meets your investment needs in terms of the above-mentioned factors. If the objectives are not relevant to you, then it might not be a good option to invest in those funds w.r.t. your investment goals.
3. Check Fees and Exit Load in Mutual Fund
When it comes to money management, it is always vital for investors to know the expenses associated with their investments, as such costs and charges may directly eat into their returns. Some expenses may be unavoidable for the investors, like fund management expenses, etc., for it adds value to the mutual fund scheme. However, investors may avoid one such charge if they diligently plan for their investment redemption, i.e., exit load.
Exit load is a charge levied at the time of mutual fund redemption if the investor redeems before the expiry of the specified period of investment in the scheme. Any exit load charged from investors is credited to the mutual fund scheme itself and does not form part of the profits of the mutual fund house.
These pieces of information are present in the offer letter of a mutual fund. As a value investor, you should try to stay away from mutual funds with high fees and loads to avoid unnecessary costs.
4. Evaluate the Past Performance of the Mutual Fund
Investing in mutual funds entails taking on a certain amount of risk. Mutual fund performance, on the other hand, maybe measured using a mathematical computation of past returns. The relationship between potential risk and prospective returns is always presenting possibilities to participate in mutual funds and generate maximum potential profits with the least amount of underlying risk.
Although the past performance of a fund will not guarantee how well it will perform in the future, however, it will give you a rough idea about the returns and expectations. This is certainly an important factor which must be checked. Moreover, you should compare the funds’ past performance to the benchmark as it will give you a better idea of its actual performance.
How to Evaluate Mutual Fund Performance
- Benchmarking is the process of comparing the quality of a fund to a set of standards. …
- Comparing to peers. …
- Portfolio quality. …
- Risk-Adjusted Returns. …
- Fund manager’s expertise. …
- Define your investment objectives. …
- Fund’s Fee Structure.
5. Analyze Portfolio and Holdings of Mutual Fund
Investing in the best assets is not enough. Because what’s best for you today may not be the best for you tomorrow! Investors either realise this too late or don’t realise it at all. But there’s a solution to this – evaluating or assessing Portfolio and Holdings of Mutual Fund.
Assessing your portfolio periodically can help you understand if you’re gaining profits or losing money. Furthermore, you must constantly nurture your portfolio to reap the rewards of profit in the future.
A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio or Holdings. Investors buy shares in mutual funds. Each share represents an investor’s part ownership in the fund and the income it generates.
This may be a little tricky for those who have zero knowledge of investing. After all, even if you find out which companies that mutual fund is investing in, how will you understand whether the holdings are good or bad?
4 Steps to Evaluate Your Portfolio
Step #1. Track Your Portfolio’s Performance
Check each investment’s returns and compare it to other schemes from the same category. This will help you understand how your investments are doing. But it’s important to note that you shouldn’t compare apples to oranges.
Comparing a stock to gold or a mutual fund scheme to P2P lending won’t get you anywhere. Instead, you can check your overall portfolio performance to gain insights.
But if this sounds lit a lot of effort, you’d be glad to know that there are trained experts who can do a financial check-up of your existing portfolio.
You can even use an MF analysis tool to evaluate the health of your mutual fund portfolio yourself.
Step #2. Check Your Portfolio Allocation
Your portfolio allocation should have an ideal mix of diverse investment options like stocks, mutual funds, ETFs, gold, p2p lending, and more. A diverse portfolio may have a better chance of giving better returns over the long term while lowering the risk.
Portfolio allocation may vary depending on factors like your investment goals, age, and risk profile. Even market trends may impact your portfolio allocation.
Example: For stock allocation, investors are known to follow this golden rule: Subtract your age from 100. Whatever remains should be your stock allocation.
At 30 years old, you would allocate 70% of your portfolio to stocks. But this could vary based on your goals.
Step #3. Identify The Fees You’re Paying
Types of investment fees that you might have to pay:
- Expense ratio
- Entry load
- Exit load
- Advisory fees
- Transaction Fee
- Brokerage charges
Pay attention to these charges since they can eat into your profits. The age-old rule applies here: lower the fees the better.
Step #4. Assess Your Goals
Your portfolio allocation is directly linked to your goals. If it isn’t, then that is a big issue that you need to address <immediately>. Goal-based investing can give you a clear idea of what should remain or be sold from your portfolio. </immediately>
For example, it would not be ideal to invest in mutual funds to finance your MBA in the next 2 years. Mutual funds are long term investments which are known to deliver profits over 5+ years.
A trained expert can help you allocate your portfolio in investment options that are suitable for your goals. Otherwise, you would be shooting in the dark hoping that something would stick.
6. Check the Credentials of the Fund Manager of Mutual Funds
The fund manager is probably the heart of any mutual fund. He/She is the one who will be making all the important buy/sell decisions on your behalf. Therefore, it’s important to find out more about the fund manager.
A fund manager is responsible for implementing a fund’s investment strategy and managing its trading activities. They oversee mutual funds or pensions, manage analysts, conduct research, and make important investment decisions. They are also responsible for managing a team of investment analysts. This means the fund manager must have great business, math, and people skills.
A manager with a long tenure may have done the job well and his/her credentials are tried out. On the other hand, the efficiency of a new manager might not have been tested yet. While researching mutual funds, check the tenure of the fund manager to find how long this fund manager is managing the fund.
Another important factor regarding the fund manager is to check which other funds he/she is managing. If the other funds are also doing equally good, then it is a good sign. On the other hand, if just one fund is performing well- while the other funds that he/she is managing are struggling, then it might be a fluff.
7. Check the Size and Credentials of the Mutual Fund House
Alternatively known as Asset Management Companies (AMC), fund houses are organizations that invest pooled in money from investors into financial instruments like equities, mutual funds, securities, etc. These companies have qualified fund managers who decide where to invest money depending on the conditions of the market. In simple words, these companies manage the money pooled from a number of investors.
Although it’s not the biggest factor, however, as an intelligent investor- always invest in the fund which has already established a good track record. It’s important that the fund house has strong credentials because mutual funds investing is a prolonged relationship and you do not want to get involved with a troublesome fund house which might give you headaches in upcoming years.
The main role of mutual fund houses is to decide when, where and how to invest the money in lieu of their declared goals. Fund managers meet investment goals by assessing various metrics like industry risks, market risks, etc. and deciding on funds to invest in.
The process of an AMC’s fund management includes the following steps –
- Allocation of Assets
- Analysis and Research of the Money Market
- Constructing the Portfolio
- Providing Performance Reviews
This Video & Information is only for Education purpose. Please read the Books and check the various financial websites to get more details about the Mutual Fund before you invest.