How To Choose The Best Mutual Fund

The best mutual fund may not always be the one giving the highest returns. It should be the one that satisfies your risk appetite while giving you stable returns to achieve your goals. Many people just go in for the returns of the fund, that too most recent returns, which can be a grave mistake.

The ratings given to these funds can be helpful to some extent, but one should consider various parameters before deciding to invest in a particular fund. This article gives a brief glimpse of these parameters to help you in your mutual fund purchasing decision. 

A mutual fund is a form of investment product where funds from multiple investors is pooled into a single investment portfolio. The fund consists of a group of assets, where the funds are invested systematically, to reach the fund's investment goals. There are a number of mutual fund products available in the market. The sheer number of mutual fund products may seem overwhelming to many investors.

This apprehension can be resolved when you have defined your goals and investment style. The general mindset of an Indian investor is impulsive and does not give much weight towards the investment objective. Investment objective is important to choose the asset class one should choose. There is also the understanding of economic outlook for the next 12 months at the least. The interest rates projection will help in deciding the duration of investment. Similarly, there are numerous other parameters one should consider before investing. Given below are a few pointers to keep in mind while selecting a mutual fund

Additional Reading: How To Invest In Mutual Funds

1. Investment Objective & Risk Appetite: Considering a mutual fund investment is a smart move. A smarter one is investing towards an objective. Defining your investment objective gives you clarity towards many aspects of your investment. Are you looking for a long term investment or something to use for a near future expense? Is the investment for a college fund or retirement corpus? Or is it for a vacation you are planning next year? Identifying a goal is necessary to invest in the right asset class. Debt funds and bonds are suitable for short term goals with low risk profile. Long term goals can use equity fund investment that have higher risk rating. 

If you are looking for regular income from your portfolio, you should go for income fund. Growth and capital appreciation funds generally do not pay any dividends. Income funds usually go for bonds and debt instruments that pay regular dividends. You can study funds based on their time horizon classifications like short term, medium or long term and choose the one that suits your objective and investment horizon. 

Your risk appetite also comes in to play. Can you bear sudden swings in the portfolio? Or, do you prefer a more conservative approach? Your returns is directly proportional to the risk you are willing to take. So, it is important to strike a balance between your risk appetite and the expected returns. 

2. Performance Ranking: Performance comparisons must be used only to compare the same type of fund. Only when used within the same category of funds do performance numbers tell you anything at all. More than the recent or long term performance of any scheme, its ranking among peers should be looked at. To find out the ranking you need to check out the quartile ranking which will show how the fund has performed quarter on quarter among its peer group. In quartile ranking, each quartile comprises of 25 percent of peer group schemes. So, one may select the scheme which has remained in top quartile most of the time. If at all you find your scheme going below 3rd quartile in a couple of consecutive quarters, it hints that time has come to exit the scheme. You can find these rankings from the factsheets of various AMCs and also on some mutual funds research websites.

3. Net Assets Under Management: Now, this aspect points towards the management ability of the company, which has translated into investor confidence on the fund. Another point to remember is that fund houses appoint their best fund managers to these funds with high AUM. Schemes with less AUM might pose risk as you are not aware of how many investors are there and what is their investment proportion. Withdrawal of any one big investor might affect the overall investment in the fund hampering the returns. Schemes with large AUMs do not have this risk. So, you can safely ignore funds with below average AUM.

4. Economic Outlook: At least the next 12 months’ economic outlook should be considered while selecting a fund. Though one cannot accurately predict the economic outlook, most of the expert economists’ view should give you a fair idea. Based on this outlook, you can select a fund that is expected to meet your investment objective. 

5. Exit Load: This is an important factor to consider. High exit load can affect your returns if you are planning to withdraw within 365 days. For example, if you have earned returns of 4% on a fund and the exit load on it is 2.5% if withdrawn before 365 days, you would be actually getting returns of just 1.5% on your investment. So, check the exit load on a fund before choosing it. 

6. Expense Ratio: Generally, funds with expense ratio of up to 1.5% are considered fine. Anything more than that is going to eat into your returns. Now, funds performing exceptionally well do not have to give much attention to expense ratio, but average performing funds need to consider this aspect. 

7. Consistency In Performance: We usually look into performance ranking of the past one year or up to 3 years. But it is wise to look into historical data to determine the consistency in performance of the fund before going for it. You may find the 1 year rating of a fund at above 4 star but the same not be the case for its 5 year performance. It is good to avoid such funds that do not have a consistent performance over a 5 year period. Have a look at the fund’s investment literature. It should give you a fair idea on the fund prospects in the years ahead and its holdings. The general business and market trends should also be addressed, which may affect the performance of the fund.

8. Fund Manager Tenure And Experience: This important aspect is hugely ignored by first time investors. Though mutual fund investments are largely process oriented, it is the fund manager who holds the final decision making power and it is important to understand their expertise and track record with managing funds. It is also advisable to have a look at other funds they are managing to understand their performance. To that end, one can use these questions to evaluate the history of the fund

• Was  the fund manager able to deliver results that were consistent with general market returns?

• How did the fund compare with other major indices in terms of volatility?

• Did the fund generate any unusually high turnover impacting cost and tax liability for the investors?

The answer to these questions will help you understand how the fund manager manages the fund in certain situations and paint a picture of the fund’s historical performance.

9. Fund Type You Want In Your Portfolio: These above aspects should have helped you decide the fund type you want to invest in – equity, debt or balanced. You should be able to choose a fund that has performed consistently well with all the economic tumults in the recent years. Remember that past performances do not guarantee future returns but nevertheless help you shortlist the most apt fund for your needs. You can refer to the below table when in need: 

Additional Reading: Top 5 Mutual Fund Mistakes to Avoid

KEY TAKEAWAYS - After reading this article, you should be able to do the following: 

• Defining your investment goals before looking into mutual funds for investing

• Take stock of your risk tolerance if you want to get optimum returns from your investment

• Decide your investment horizon to narrow down on the right type of fund to invest in

• Study the Fund Manager and the historical data on the fund to make an informed decision

Investors should understand that mutual fund is no different than any other investment in market instruments. Though it is a safer way, it is not entirely risk free. No one is an expert in timing the market but, studying the trend helps in decision making. Investors have the option to look into other investment options like Exchange Traded Funds that can give better returns with low risk. They should also consider investing in Systematic Investment Pland to invest systematically, which gives them greater control on their investments.