Selecting appropriate mutual funds is the backbone of your investment goals. Before analyzing mutual fund schemes that align with your needs, you should focus on 3 things –
- Investment objective – why you are investing in mutual funds
- Time horizon – For what time period you are going to invest in mutual funds.
- Risk appetite – How much risk you can endure getting desired returns. A balanced approach is ideal for healthy returns without taking much risk.
Once you have considered the above 3 factors, you can now analyze the below-discussed points to select the appropriate mutual fund scheme.
Before discussing important points on how to select the mutual fund, you can have a look at major mutual fund categories you should be aware of –
|Time Horizon||Mutual Fund Category||Risk Factor||Return on Investment|
|1 month to 3 years||Debt funds||Low||Low|
|3 years to 5 years||Hybrid/Balanced Funds||Moderate||Moderate|
|Above 5 years||Equity Fund||High||High|
Let’s discuss how to select mutual funds in detail.
9 Steps to Select Mutual Funds in India 2022
#1. Check Rolling Returns
You must check the past performance of a mutual fund to understand whether the fund was consistent in giving better returns or not.
Most people check Point to Point Returns to analyze the performance of a mutual fund but Rolling Returns give you a more accurate idea of how a fund performed in the past.
Point to point return means when you check from a fixed certain period of time. For example, you can check a 1-year return, a 2-year return, or maybe a 5-year return. These are point to point to returns.
In rolling returns, you check at the variable time frame. This means if you want to check the 5-year performance of a mutual fund. You would check 1 to 5-year performance, 2 to 5-year performance, 3 to 5 years performance, and lastly 4 to 5 years performance.
Rolling returns provide you better insight as you can check at what time period a mutual fund’s performance was down, and when it was down, was it able to protect your funds from losses, or had it performed better than average category returns or not.
#2. Portfolio Turnover Ratio
The portfolio Turnover Ratio shows which of the fund’s holdings have been changed over the past time period (mostly last year).
You come to know what strategy that the fund manager is using to generate returns on investment.
A low turnover ratio tells you that it’s a buy-and-hold strategy. That means the fund manager is confident about the stocks he is holding and he is planning to hold them for the long term or maybe for the entire fund horizon.
Such a mutual fund has a low expense ratio because of low transaction costs. Mostly such funds offer a consistent return over time making them a good bet for investors.
But, some fund managers put most of the money in one sector which they expect to give better returns in the future, this practice may lead to losses if that sector doesn’t perform well.
The reason for fund managers doing this is to increase short-term yearly returns which leads to attracting more investors to that fund scheme.
If you analyze the portfolio turnover ratio of a fund before investing, you may come to know that whether the fund manager is looking for long-term consistent returns or short-term high returns to attract buyers, and avoid investing in such funds.
Always look for a well-diversified mutual fund means your money should be invested in good proportion to different sectors like banking, IT, Pharma, or FMCG, rather than betting a major chunk in one sector.
#3. Fund Performance (Category, Benchmark & Sectoral)
Check the long-term track record of mutual funds and compare its performance with other peer funds in the category. For example, if you looking for a large-cap fund, compare your shortlisted fund with other large-cap funds and check how it performed in the past especially during bad times.
You can also check if the fund is delivering better returns than the benchmark index or not. For example, if you are investing in a fund that is focused on the banking sector, the benchmark index would be the index of banking stocks.
If a fund is offering better returns than the benchmark index over a reasonable period of time (5-7 years), then that could be a better choice.
But 1 more thing, do understand that whether any sector mutual fund focusing is down or if there are any chances it won’t perform in future, then you can avoid that.
Also read – Top 10 mutual funds in India
#4. Fund Manager Track Record
Another important factor is checking the fund manager’s track record in the past and how long he has been with that Asset Management Company (AMC). You can look at the fund manager’s experience, by tracking the funds he managed in the past, and how those funds performed along with other funds currently managed by him.
Track for atleast 5-6 years record that would show you the clear picture.
Try to choose a fund that has not been only consistently outperformed its benchmark but also endured a few market downfalls. That will show the expertise of the mutual fund manager.
#5. AMC or Fund House Track Record
An Asset Management Company (AMC) or a fund house, is a company that operates a mutual fund scheme. For example, Axis Mutual Fund is the name of the AMC which manages schemes like Axis Small Cap Fund.
AMC or its fund manager takes the decision of investing your money in which segment in expectation of good returns along with reducing the risk.
You must know the track record of the AMC of your shortlisted fund so that you can understand if the AMC has taken the right decisions in the past to provide not only better returns but also protect its investor’s money from market downturns.
For that, you must check out out the fund history of multiple funds operated by AMC in the last 6-7 years.
#6. Low Expense Ratio
The expense ratio is the fee that an AMC charges from you for managing your investments in the mutual fund scheme. It also includes the fund manager’s fee take care of all investor’s funds and ensuring profits against their invested money.
Always look for a mutual fund with a lower expense ratio. You might be thinking of it as a very small percentage but if you calculate across your total investment portfolio, it may have a deep impact on the overall returns.
The expense ratio is the opposite of Assets Under Management (AUM) or fund size and generally, the higher the AUM, the lower the expense ratio. Because the fee will be distributed among more investors.
So you can go for high AUM with other factors considering in mind that would lower the expense ratio.
#7. Entry And Exit Load
Entry load is the fee that a fund house charges from investors to start investing in their mutual fund scheme. However, most fund houses have removed the entry load from their schemes but the exit load is still there.
Exit load is the fee charged by AMC from investors upon exiting the mutual fund scheme. Most equity mutual funds come charge exit load because equity mutual funds are considered for long-term investment and if you redeem your fund units before the said time period, you have to pay the exit load fee.
Remember, exit load is separately charged from the expense ratio.
Check out – Best Index Funds in India
#8. Tax Consideration
Mutual funds are a good investment type in terms of post-tax returns. But you should look into it carefully before investing in a mutual fund. Let’s have a look at taxation types on mutual funds as below.
|Tax Type||Equity Mutual Funds||Debt Funds|
|Long Term Capital Gains||10% on the gains above Rs. 1 lakh per year for a holding period of 12 months or above||20% (after indexation) if the holding period is of 36 months or above|
|Short Term Capital Gains||15% on the gains if the holding period is below 12 months||As per the applicable income tax slab|
#9. Direct or Regular Plans
Mutual fund schemes are of two types – direct and regular.
In a direct mutual fund, you buy mutual fund units directly from a mutual fund company, whereas in a regular mutual fund, you buy through an intermediary or, a broker.
Since you are buying directly, so you don’t have to pay any commission on the direct plan.
But in a regular plan, you have to pay some fee that an AMC charges from you against the commission it pays to the intermediary against their sales.
That’s why regular plans then become more expensive than Direct plans and you can check that regular and direct plans have different NAVs (mutual fund unit price).
If you are confident about your knowledge of mutual fund analysis and you can do your own research then it’s good to invest in direct plans and avoid paying commissions.
But if you are a newbie and you don’t have much expertise in mutual fund selection, then buying through an intermediary is beneficial because the broker would help you choose the right fund as per your investment goals.
Selecting the right mutual fund is a critical process to the overall success of your investment goals. If you generally check out any platform you might get confused with so many options at hand.
So after identifying your investment objectives, planning your time horizon, and calculating the risk appetite, you can make the final decision based on the above 9 points.
If you have gone through the above 9 steps carefully, you can shortlist the best mutual funds that align with your investment goals.