How to select a mutual fund?

Mutual funds are seeing an influx of investors because of their attractive returns and diversification benefits. However, every investor must note that no single mutual fund scheme or schemes is ideal for everyone. A suitable mutual fund is the one which matches an individual’s investment objective and is in line with his/her risk appetite. These, along with many other factors, must be considered before investing in a mutual fund.

A common question that most new investors ask is ‘how to select a mutual fund’. Here, our experts have put together some of the basic techniques, strategies, and factors to consider while selecting a mutual fund.

Points to consider while selecting a mutual fund scheme?

Some of the factors you should consider while selecting a mutual fund are

Individual investment Objective vs mutual fund objective

As a first step, an investor must weigh his/her personal investment objective against that of the shortlisted mutual fund schemes. Investors must choose a mutual fund scheme that is right for personal needs. Irrespective of short-term or long-term goals associated with specific events of life or a family member, it’s essential to read the mutual fund scheme’s offer document carefully before selecting one for investment.

Risk taking ability

Every individual has a different risk appetite. Some can take higher risk, while others may prefer moderate to minimal risk. Risk appetite may also vary depending on the life cycle stage an individual has reached financially. For those who are in their 20s and don’t have any dependents, equity mutual funds can be a good choice. Balanced funds are ideal for those in the age group of 25-30 and married individuals. Before selecting a mutual fund, it makes sense to understand one’s risk-taking ability and compare it against the available mutual fund options.

The table below depicts various risk levels and mutual fund categories that are ideal, as per the risk and time horizon preference of an investor.

Risk LevelShort Term(0-3 yrs)Medium Term(3-5 yrs)Long Term(>5 yrs)
Low RiskLiquid Funds, Ultra Short-duration FundsShort-duration FundsLarge Cap Funds
Medium RiskShort-duration FundsBalanced Advantage FundsMulticap Funds
High RiskArbitrage FundsEquity Hybrid FundsMid Cap Funds, Small Cap Funds

Investment time horizon

The investment time horizon is the time period for which an investor wants to remain invested in a mutual fund scheme. This can range from short durations such as 1 day or longer time periods such as 5 years. Investors can choose from different fund categories to suit their different time horizons. Some mutual funds may invest in short-dated debt instruments, and others may invest in longer term fixed-income instruments. Equity funds are ideal for an investment horizon beyond 5 years.

Investors must be aware that short term mutual fund investments will be subject to market volatility but could generate higher earnings. Mentioned in the table below are various time horizons and the mutual fund categories that are best suited to each.

Time HorizonMutual Fund
1 day – 3 monthsOvernight funds, Liquid Funds
3 months – 1 yearUltra Short-duration Funds
1 year – 3 yearsShort-duration funds
3 years – 5 yearsHybrid/Balanced Funds
More than 5 yearsEquity Fund

Assets under Management 

AUM or Assets under the management of a mutual fund is the total fund size. The size of a fund also reflects its potential. It reflects why investors are choosing one fund over another mutual fund. A higher AUM also increases the fund exposure. This could increase the overall risk of the mutual fund. It requires the best and most experienced fund managers to manage funds that have high assets under management. Hence, while checking a fund’s AUM, investors must also check the fund manager’s experience and past performance.

Performance measurement of mutual funds

Mutual fund schemes are often compared against benchmark index for performance and stock composition. The benchmark index for a large cap mutual fund, for example, will most likely be an index comprising large-cap stocks. It is also important to assess the performance of a mutual fund scheme in line with its peer group. While comparing one mutual fund scheme against another, investors must ensure that they are the same type of mutual fund schemes. For example, a large cap equity mutual fund must be compared only with other similar large cap mutual funds, as against a mid-cap or small cap fund. 

Performance consistency

A good mutual fund generates consistently good returns for investors over a period of time. Investors must look for funds that can generate consistent returns during market upswings as well as downswings. This can be assessed by looking at the historical performance of a mutual fund scheme.

Total expense ratio

The fee charged by an AMC pertaining to administration, management, and related activities of a mutual fund is also known as its expense ratio. It includes all the expenses that are incurred in the functioning of the mutual fund. As per SEBI, the maximum expense ratio that can be charged by a mutual fund is capped at 2.25% of its total assets. Direct plans of mutual fund schemes generally come with a lower expense ratio as compared to the regular plans. This is because direct plans do not involve any distribution commission. Investors must note that the lower the expense ratio, the higher the net returns that can be availed from a mutual fund scheme.

Exit Load

Exit load are the withdrawal charges that an investor has to pay at the time of liquidating (or redeeming) the mutual fund investment. These charges depend on the duration that an investor remains invested in the fund. In case of an early withdrawal before the maturity period, an investor must pay the exit load. Therefore, investors who are looking for higher liquidity must avoid investing in plans that have strict exit load guidelines. This will reduce the impact of exit load on total returns generated by an investor.

Fund Manager’s Experience

Checking the mutual fund manager’s past track record is of utmost importance. This can be done by analyzing the performance of all the funds that have been managed by him/her in the past. A fund’s performance during market fluctuations must especially be looked at while gauging the fund manager’s capability. Investors must also look at the total years of experience that the fund manager has been managing a particular fund. 

How to select and invest in a mutual fund through Finity?

Finity is an app based investment platform over which you can invest in direct mutual funds with zero fee and zero commission.

Investors who are new to mutual funds can download the Finity app to select and invest in mutual funds of their choice. The app is designed to provide a list of top-performing mutual funds based on the investor’s risk ability, investment time horizon, investment goals, etc. The funds are chosen based on research and recommendations from a Smart Engine that weeds out non-performers and shows you the best funds based on your needs.

The entire investment process is seamless through Finity since it can be done through a smartphone.

Conclusion

The various factors discussed above can help investors in selecting and investing in a mutual fund. It is important to do some amount of homework while searching for the right mutual fund scheme. Investors must also keep a check on the chosen mutual fund for at least 6 months (for medium-long-term investments) to ensure that it is able to fulfil their investment objectives.

FAQs on mutual fund selection

  1. Can I invest Rs. 500 in a mutual fund?
    Yes, you can invest a small amount like Rs. 500 in a mutual fund through the SIP option. SIP or systematic investment plan allows investors to invest small amounts of money in mutual funds at predetermined intervals. Some funds allow you to start investments with just Rs 1000 as well.
  1. How do you make money from a mutual fund?
    An investor can fetch returns from a mutual fund in three key ways:
  1. Dividend income from stocks and interest income from bonds held in a mutual fund’s portfolio. 
  2. In case the mutual fund sells securities due to price rise, the fund gets a capital gain which can be passed on to investors.
  3. If the mutual fund holdings increase in value but are not sold, the fund’s share prices increase. Investors can gain by redeeming these units, depending on the scheme.
  1. Is it better to buy stocks or mutual funds?
    A mutual fund offers diversification as investors can gain exposure to a variety of stocks within the same basket. Investment in a mutual fund is recommended over individual stocks, especially for new investors, since individual stocks may carry higher risk as compared to a mutual fund. 
  1. What happens to mutual funds if the market crashes?
    Mutual funds that primarily invest in equities are often exposed to the risk of market fluctuations. A mutual fund performance could be impacted during a downswing in the market. The extent of impact will, however, differ across mutual funds, and it depends on the composition of the fund among many other factors. So, if you are investing in equities, you should remain invested over a longer period of time to make good returns.
  1. Do I need a demat account for mutual funds in India?
    A Demat account is not essential for investing in mutual funds. Mutual fund investment can easily be done using the Finity app from your smartphone.

Leave a Reply

Your email address will not be published. Required fields are marked *