7 steps to select the right mutual fund

Selecting the right Mutual fund is like selecting the right partner; any wrong decision can put you in a spot of bother.   As a new investor you may find it even tougher as there are so many funds to invest in. 

When we say we need to select the best mutual fund for us, it does not mean the one with the best returns, but the one which suits your goals and the amount of risk you can take. Many investors make the mistake of choosing a mutual fund based on past performance, if a mutual fund has been the best performing one in the last year, it does not mean it will continue to do the same. Some investors only look at the ratings given by various research agencies. This can be one parameter to be looked at, but there are many other parameters that one should look into before investing in a mutual fund.

1. Investment Objective:  Firstly, you need to understand your purpose behind investing. You may be investing for a long term or short-term goal or for a specific goal like child’s marriage or education, foreign trip with family, purchase of a new car or house. Investing in mutual funds to get better returns then saving account and fixed deposit can also be a goal. Read the scheme related documents carefully and understand the investment objective of the mutual fund scheme and check if it is in line with your objective

2. Risk Tolerance: Investment decisions are taken based on risk appetite. A person in their mid-twenties would be a high-risk taker and invest in equities whereas a person who is likely to retire soon would prefer safer investments like debt funds. To make investors aware of their risk profile, SEBI in 2015, made it mandatory for all mutual funds to display a RISKOMETER, showing five levels of risk.

3. Performance comparison: Mutual fund returns should be compared to a benchmark’s performance and other schemes in the same category which will give a better understanding of the fund’s performance. For eg: If you have invested in a large cap equity fund then your basis of comparison will be other large cap funds in the same category and not mid cap or small cap funds.

4. Consistent returns: Mutual funds giving consistent returns over a period of 3-5 years should be considered as investments. Don’t look at the investment performance of just 1 year, there are many schemes which have good ratings and good returns in 1 year but poor returns over a period of 4-5 years.

5. Expense ratio: Expense ratio is the fee charged by an AMC for maintaining all the expenses for running the mutual fund which include the administration, management, promotion and distribution of a mutual fund. According to SEBI, mutual funds can charge 2.25% of the total funds’ assets as expense ratio. However, most equity mutual funds charge around 1.5% which is considered as good by industry experts. Higher expense ratio will reduce your profits and increase your losses.

6. Fund manager tenure and experience: Fund manager is the one who takes most decisions while managing the fund. You should know who the fund manager is and is past track record. Keep yourself updated with other funds that he is managing. However, if the fund manager has recently been changed, don’t panic, track his performance on a quarterly basis. If you find out that the decisions taken by fund manager effects the fund considerably and does not suit your risk appetite, then you can take a decision to exit.

7. Assets Under Management: You can compare the fund size with that of its peers within the same category. Choose the one that is neither too big nor too small. Too big a fund makes it difficult for the fund manager to effectively generate returns and too small a fund shows that the fund is not that popular.