Know the top 5 steps to select the right Mutual Fund

Let us understand the key steps to select the right mutual fund for long term wealth creation.

Sep 19, 2019 11:09 IST India Infoline News Service

The task of picking the right mutual fund can be rather mind boggling given the multiple categories and sub-categories of mutual schemes available in the market. If chosen carefully, some mutual funds have the capability to double one’s wealth over the long term. However, selecting the best mutual funds to suit one’s requirement becomes difficult. Moreover, mutual fund investment is riddled with numerous perceptions, myths and opinions, and investors are likely to get lost in this maze. There are certain factors that an investor can check before investing in the best mutual fund for himself. Investment and selection of the right mutual fund depend on the following factors:
 
a. Your age
b. Your risk appetite
c. Size of the investable corpus
d. Financial goals to be fulfilled
e. The time horizon based on your goals
f. Mode of investment (SIP/lump sum)
g. Purpose of investment (like Tax planning)
 
Once you have understood and decided on these factors, then the next step is choosing the right mutual funds to fulfil these objectives. Here are some things you need to tick mark before investing in a fund:
  • Fund Manager Experience: Every mutual fund is managed by a fund manager whose job entails making investment decisions based on in-depth research and investment methods and in the process maximizing investor returns. If you want an experienced manager calling the shots for your mutual fund, then choose someone with at least 7-10 years of experience. The more experienced the fund manager, the higher chances of generating alpha (returns over and above the benchmark). However, there are many managers who mentor their successors for several years. So, a fund with a new manager can also be worth considering if the fund has consistently performed well.
  • Investment objective: Every mutual fund scheme, irrespective of the category, whether equity or debt, has an investment objective. It is this investment objective which entails them to invest in various asset classes in defined proportions. As an investor it is imperative to check the investment objective of the respective mutual fund scheme, and thereby see whether it aligns with your end goal. For example, if you have an objective of capital appreciation with a long-term investment horizon in mind and are willing to take risk, then equity oriented mutual funds will work better for you.
  • History of the fund house: When you invest in a mutual fund, you are trusting the fund house to manage your money. This is why the pedigree of the fund is important. Decisions taken by the fund house and the fund manager may have a direct impact on your investment's performance and the realization of your financial goals. Hence, it is important to do a check on the fund house, history of existence and track record across schemes before selecting a scheme.
  • Historical returns: While past performance is no measure or guarantee for future returns, a fund house giving consistent returns denotes efficient processes and sound management practices. Knowing how a fund has performed in the past can’t tell you how the fund will perform in the future, but it can tell you how the fund compares to other funds with the same investment objective. Ideally, you should review a fund’s performance for a couple of years and how it performed in different market conditions. Funds that have not just performed well when the markets are doing well, but the ones that have remained sturdy even during a slump, are the ones to watch out for.
  • Expense ratio and other charges: This is something that is overlooked many a times. An exit load is the charge levied when you sell your units of a mutual fund within a particular tenure. As exit load is a fraction of the NAV, it eats into your investment value. Thus, it is important that you invest in a fund with a low exit load, and more importantly stay invested for the long term. There are other expenses like expense ratio, which need to be compared across similar funds. Comparing the fund’s costs and performance against those of similar funds will shed light as to the kind of value you’re getting for your money. A fund with a lower expense ratio and low exit load among other charges is always preferable.
  • Size of the fund:  Invest in funds that are neither too big nor too small. Somewhere in the range of Rs3,000-10,000cr should be sufficient. This is because small funds tend to have high fees. Large funds tend to have a problem of allocating money efficiently
  • Turnover ratio: Turnover refers to how often investments are bought and sold within the fund. A low turnover ratio of 50% or less shows the management team has confidence in its investments and isn’t trying to time the market for a bigger return. If the turnover ratio is high, it’s better to skip the fund.
  • Growth vs. dividend: If your goal is to maximize profit, it’s always better to choose growth option rather than dividend. Dividend will give you regular income but growth will give you better returns in the long term due to the power of compounding.
  • Sharpe ratio: Sharpe ratio is the measure of risk-adjusted return of a financial portfolio. A portfolio with a higher Sharpe ratio is considered superior relative to its peers. As a thumb-rule, the Sharpe ratio of a good fund will be higher than the benchmark.

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