Whether you are investing in mutual funds for the first time or not, picking the right fund every time is crucial for the returns you expect from your investment. However, there are hundreds of mutual fund schemes spread across multiple asset classes and mutual fund categories, which need to be clarified for investors.
Understanding the proven process of picking the right mutual fund scheme experts have used for years
Understand your financial goals
First, you need to clearly understand your financial goals, such as buying a house or planning for early retirement. In simple words, you need to know what you want to do with the amount you accumulate with the mutual fund. This is important because if you want to buy a house in the next ten years and invest in overnight debt funds, it will not fetch you the returns you need to fulfil your goal, right? So, noting down your financial goals is the first step towards picking the right mutual fund.
Check your risk appetite
Then comes your risk appetite. Now suppose you have this goal of buying a house for which you need to invest in funds where the returns are high, but that also comes with higher risk. To accumulate the funds for the house, you put the money into small-cap equity mutual funds, which offered negative returns after a year. You panicked, withdrew the entire amount, and lost a portion as the fund value went south.
However, if we check the fund’s long-term returns, we can see that the fund actually offered expected returns. But you couldn’t hold on to the investment because of your lower risk appetite. So, while choosing funds, you need to analyse your risk appetite and also have patience when investing in equity funds for the long term. Read our blog How to Effectively Evaluate Mutual Fund Performance to know more insights.
Diversification
The third factor is like reiterating the old saying ‘Don’t put all your eggs in the same basket’ and yes, even if you have a high-risk appetite and your financial goal is long-term but putting all the money into equity mutual funds in that scenario can prove highly risky for your portfolio.
To mitigate the risk, you need to allocate your assets wisely in both equity and debt funds.
Performance of the fund
While the fund’s past performance doesn’t indicate future returns, analysing the past performance can help determine how the fund has performed at different stages.
There are a lot of ways of analysing a fund’s performance. You can check the average return of the fund since inception and compare it with the benchmark index or rolling return, trailing returns, and compare with category average as well.
Ratios like the Sharpe ratio, Beta, and Alpha of the fund can help you analyse its performance as well. They help in understanding how the fund has been performing as well as to analyse risks.
Also, check the risk-adjusted return or the downside risk protection of the fund, as this will clarify the fund’s risk-return ratio. Information related to the fund size and the fund managers who handle the fund can also be helpful in analysing the performance.
Expenses
When choosing a fund, it’s important to look beyond just the potential return. You should also take into account the expense ratio and exit load. It’s essential to carefully evaluate the expected return and overall cost of investing in the fund, including any fees for closing or withdrawing from it.
Conclusion
Choosing the right fund can be a difficult process. We hope that after reading the article, you are able to understand the different aspects that go into selecting the right mutual funds.
Moreover, you can contact your mutual fund distributor or registered investment advisor, who can help you with this process and suggest the best mutual funds that meet your requirements.
