I want to learn
- Mutual Funds
How to choose best mutual fund
Choosing a mutual fund is like choosing a friend for life time, it is one thing that is going to help you achieve your future goals and be there with you in good times and in bad. If you spend your life with a wrong mutual just like a bad company, you may end up creating obstacles to achieve your dreams.
What does “Safe” mean to you?
There are different connotations as per different investors. For one safe is guaranteed returns, for another at least my principal should be protected while few think that my money should grow irrespective of market condition.
Doing safe investment doesn’t only depend of the product you choose but it starts from the time you pick your product. Understanding own risk profile, time horizon, financial needs and purpose of investment.
But,how to choose best mutual fund in India
- Avoid the rating trap
- Look at the AUM of the fund
- Identify you goals and understand your risk profile
- Quality of securities
- Consistency of performance
- Expenses ratio
A best mutual fund is something which feels like couture, it should be parallel to your risk profile and time horizon of investment. Here are some tips to choose best mutual fund.
Avoid the rating trap:
Being is smart investor you should always look at start rating of the fund given by different mutual fund analysts, mutual fund website etc. However, this should not be the sole parameter to decide which mutual fund should be picked for investment. It’s important to understand what those star rating mean.
Start rating is not only based on performance of the fund but also, it’s a comparison with in the category, high rating doesn’t mean that the mutual fund is best performing of the entire category. Like we have ranking system in schools, the student ranked number one doesn’t mean that he or she is the best student in world, but in the specific class.
Look at the AUM of the fund:
AUM of the fund follows diminishing marginal utility, which means, after a certain level of AUM it starts affecting the fund performance in negative way. Excess of money available with the fund manager makes is default to trade and which in turn affects the performance. Many time fund managers may hold huge amount in cash because of lesser opportunities to utilize the capital.
Identify you goals and understand your risk profile:
It’s not about how to choose the best mutual fund, it’s about you need to know what is best for you. One should understand their own requirement first. Try to identify how much time you have left till you need your money. What is the amount that you need to achieve that goal? If you are investing with a goal, you are just sailing without any direction and may dive in trouble anytime. List down all your goals and design an investment plan accordingly.
Always keep some portion aside for emergencies and contingencies. Understand your risk profile is also very important while choosing the best mutual fund. Investors many times blindly invest in funds occasionally performing well, they don’t understand such funds may have higher exposure towards small and mid cap which are very volatile and may not suite your risk profile.
Understanding your risk profile is different from willingness to take risk. A person with huge loans may be willing to tale higher risk just to earn higher and clear his loans early but ideally he should take moderate or lower risk because of his financial commitments.
Quality of securities:
While selecting best mutual fund for SIP or lump sum, it’s very important that you look at the quality of securities too. Investors always consider debt funds as no risk or low risk mutual funds. However there are various risk parameters that can affect debt funds too. Especially while selecting debt fund one should always look at the percentage of allocation toward AAA or AA rated bonds. Having higher exposure towards low rated bonds will increase the default risk for the fund.
Consistency of performance:
Consistency is performance is the key. Investors usually look toward 1 year returns and start assuming that the fund is a winner, however, always look towards 3 t 5 years returns to understand how consistent is the performance. For example a fund is last 1 year has given 15% returns and 3 year CAGR is 4%, however there is another fund which has generated 12% last year and 3 year CAGR is 10%, which one will you pick?
It’s OK if the fund performance is a little lower than the occasional winner, always run behind the consistence of the mutual fund performance. There occasional returns can be because of some marker favorable conditions or because of a specific sector performing well, it will be difficult for this fund to repeat the history, and however, the consistent performing fund is always the winner.
Moderately high-risk level
These mutual funds have good exposure in equity and related instruments. They are usually balanced and equity oriented, index, diversifies and ETFs. Products under this label are suited for investors seeking to create wealth over a long period of time. Investment in equity under such funds is related to the large-cap segment.
Be it direct fund or regular fund, the cost to manage the fund always exists. This cost will be adjusted in your profits, so always look towards the expenses ratio of a fund because you don’t want to end up paying more cost than your returns.
Important ratios while selecting best mutual funds?
- Standard deviation
- Capture ratio