How To Choose A Mutual Fund For Investment

Last updated on 24 May, 2018 | 2 comments

how to choose mutual fund

When you want to invest in mutual funds, you are at a sea. You have to choose a mutual fund for investment out of 6000 funds present in India.

This would be a Herculean job, if not planned well. You have to know certain things before proceeding. The list is not very long but, requires a careful study of the scheme you want to invest.

Focus on Your Need
The very first thing in choosing a mutual fund is to focus on your objectives. Everybody has a reason to invest in Mutual Funds. But everything is not for everyone. So, choose your own fund that will cater your need. If you are young and have a long tenure, invest primarily in equity growth funds rather that debt funds. If you are a retired person, debt funds would be an ideal choice for sustainable income. Again, if you are investing for a short period, ultra short -term debt funds would be the best. As we focus on our needs our options would be fewer.

The objective clarifies the risk appetite of an investor. And it’s become easier for an expert to offer funds.

Know About the Fund House
Your money in mutual funds is going to be invested through a fund house, known as Assets Management Company (AMC). AMCs are the trustees of your money. They manage funds through their fund managers. It’s important that your fund houses are of good repute. It doesn’t require that the fund house should be the oldest one but holds a good reputation in the market.

The fund houses should have a clear objective and consistency in their performances. Remember to evaluate the fund houses on long term basis. A trustworthy fund house never works against the investor’s interest.

Evaluate Fund Performance
This is the vital thing you have to check. Selection of a mutual fund depends primarily on return. You should evaluate a fund for different time periods and compare them with the benchmark index and other peer funds. Normally a comparison between the funds and benchmark is available in the fund’s websites.

Evaluate equity funds from long terms perspective say 3-5 years. But, for debt funds take short or medium term view.

Quartile ranking is one of the good techniques to rank funds. Quartile rankings are a measure of how well a fund has performed against all other funds in its asset class. The rankings range from 1 to 4 for all time periods covered. Quartile rankings are compiled by sorting the funds by one-year return. Funds in the top 25% are assigned a ranking of 1; the next 25% are assigned a ranking of 2, and so forth. If a fund drops below 3rd quartile in a couple of periods consecutively, it is better to exit or avoid it.

Analyse Funds Technically
If you are selecting funds yourself, you cannot merely depend on return on investment yardstick. You have to go beyond. You have to evaluate funds with ratio analysis like Standard Deviation, Sharp’s Ratio, Alpha analysis and Beta analysis.

Standard Deviation (SD) measures the volatility of the returns from a mutual fund over a period of time. A low SD indicates consistency in the return of a Mutual Fund.

Sharpe ratio measures how well a Mutual Fund has performed vis a vis risk taken by it. Higher the Sharpe’s ratio, the better the fund has performed.

Alpha of a mutual fund indicates the excess return of a fund compared to its benchmark index.

Beta measures a mutual fund’s volatility compared to that of a benchmark.

Check Loads and Recurring Expenses
This is a truth that most of the investors don’t look into the expense ratio of a fund house before investing. But unfortunately, these fund house expenses affect the returns of the mutual fund over a long period of time.

Another expense is the exit load; an investor has to look into. He/she should read the offer documents carefully to understand the exit load. Fund houses collect the exit load at the time of redemption from an investor if withdrawn before a specified period. Exit load differs from fund to fund.

Evaluate Fund Manager’s Performance
Experience and performance of fund manager is vital to the success of a mutual fund scheme. Before investing in a mutual fund scheme you should check the previous track records of the fund manager.

A good fund manager has the ability to transform dead fund into a top gaining fund.

Portfolio Diversification
The success of a mutual fund depends on how diversified its portfolio is. A diversified portfolio is better than a sectoral portfolio.

An investor should look into the scheme portfolio and evaluate the risk associated with it.

If the investment of a mutual fund concentrates more on a specified sector or stock, the chances of gains and losses are high. Because a small movement in the market may make the fund highly volatile and so their prospects.

Asset Size of the Mutual Fund Scheme
Though the scheme asset size is not a primary criterion for choosing a mutual fund, yet it matters. It defers from scheme to scheme. The Asset size of the debt funds is normally many times bigger than the equity funds.

If the asset size is comparatively smaller then there is a risk. The exit of any big investor from such a scheme may impact the overall performance of the mutual fund which the small investors have to bear. Hence, It is advisable to avoid small asset size funds for investment.

The points given above are purely based on technicalities. In real life, it would be hardly possible to find out a perfect fund for investment. Because the parameters mentioned above are overlapping each other in some way or the other. Moreover, past performance of a mutual fund does not guarantee about its bright prospects. So, in addition, to the judging a mutual fund on the above parameters, an investor should use his own prudence for better results.