Selecting mutual funds to invest in is not as easy as deciding where to buy your next cup of coffee. You do not just make a random choice; rather it must be an informed choice that you must be willing to stick to for the next decade or more. The new-age investors may argue how looking at past year returns is enough to decide which funds to include in an investment portfolio. However, there is more to choosing mutual funds than just previous years’ returns.
Mutual fund investors must pay attention to various parameters including risk appetite, fund returns since inception, benchmark returns, investment horizon, expense ratio, fund manager performance, and the size of the assets under management (AUM). Many people also look at the portfolio turnover ratio too to assess how much churning of the portfolio is done every year. Too high a portfolio turnover ratio underlines volatility though it also indicates how quickly the fund manager responds to macroeconomic factors.
Many investors adopt the Do It Yourself (DIY) approach while others seek professional financial advisors’ guidance to learn which mutual funds would help them achieve their financial goals as planned.
Know why you are investing
Mutual funds must be chosen in sync with one’s goals. Not everyone invests in mutual funds for the same reason. Some start putting money early in them as a part of their retirement planning process. Still, others save and invest money in them to pay for their dream house, a much-awaited vacation, or distant dreams like children’s higher education or marriage. This means that you must be aware of the purpose of your investment before deciding to allocate money to any mutual fund.
Types of mutual funds matter
There are myriad types of mutual funds. While some of them pertain to equities, others invest in debt instruments or commodities like gold and silver. Still, others invest in bonds and real estate, thus, hinting at how not all mutual funds are not the same.
Asset allocation is another element that differentiates one category of mutual funds from the others. Some funds invest in 100 per cent equities, some completely into debt, while others boast of an appropriate mix of equities and debt or equities, commodities, and a bit of real estate investment.
Next, we must look into how some of these funds behave or respond to market fluctuations, i.e., how likely they are to go up or down in response to news in the market. For example, market swings affect equity mutual fund investments. As a result, an equity-oriented portfolio may experience volatility in the short term. However, you cannot ignore how returns from them can be significantly higher than those of other types of funds. These funds may be appropriate for long-term aggressive investors.
However, debt mutual funds are more stable in comparison. However, the returns may be lower than those of equity funds. These may be appropriate for conservative investors or those looking to stay invested for a limited tenure, say five to seven years.
Target Maturity Funds (TMFs) are another kind of investment that many investors put their money in hoping to benefit from the yield to maturity (YTM) promised at the launch of the offer. However, one must be careful of misinterpreting the purpose of buying TMFs based on their name alone. Rishabh Parakh, Chief Play Officer, NRP Capitals shared, “TMFs do not provide 100 per cent guaranteed returns. It’s important to carefully consider this choice, especially since TMFs no longer offer the benefit of indexation.”
Do not ignore liquidity concerns
Investors should be aware of when they may need money before making an investment. That is, if there is a demand in the near future, it will not be for equity mutual funds. This is due to the possibility that it will not give returns as expected.
Equity mutual funds can provide projected returns if you are willing to stay invested in them for a decade or more. A prolonged investment tenure ensures that you benefit from the compounding effect. This helps considering how compounding works best when money is allowed to grow for extended periods. If you need money quickly, liquid funds are the way to go.
Liquid funds are a kind of mutual fund where you may allocate your earnings depending on how frequently you might need money or while setting aside an emergency corpus to meet sudden, unforeseen needs in the future.
Check the investment philosophy of the fund house
There are winners and losers in every field, which is why you must be aware of the fund manager’s past performance before deciding to trust him or her with your hard-earned money. Irrespective of which way the market goes, a fund manager’s outlook can always help you to stay afloat. This also explains why some funds lose more than others when the market is bearish while others are not affected to such an extent. The quantum of difference between the returns during downturns underscores their flexibility in responding to market changes and their adaptability to changing situations.
The majority of investors disregard this facet of investing. However, it is critical to the success of your investment portfolio. Evaluating the investing approach of the asset management company (AMC) is important. This strategy is synonymous with their investment plan and is used by fund houses to make all investing decisions. There will always be a conflict of interest if the fund house’s investing strategy does not align with your investment philosophy. A major difference between the both can force you to sell your investments at a loss.
Do you take care to check the entry and exit loads of the fund in which you are investing? There is no “Entry Load” applicable as per SEBI guidelines in 2009. However, you must be willing to check for any “Exit Load”. Not many investors are aware of why fund houses impose a fee when departing a mutual fund scheme. The idea is to refrain investors from leaving after a short investment period. Also, this helps to discourage fast exits and capital outflows from fund houses.
Direct or regular plans
You must check if the plans are available as “Direct” or “Regular” plans. Also, check for added features like Systematic Withdrawal Plans (SWPs) and Systematic Transfer Plans (STPs) before deciding how to invest, why to invest and which plans to invest in.
Investing in mutual funds has become a necessity considering how inflation is causing a constant devaluation of the Rupee. Putting money in funds that yield returns beyond inflation ensures the accumulation of the much-needed corpus for a more secure future.