Top 10 Tips On Investing In Mutual Funds

If you though that investing in mutual funds can be a breeze thing again. One of the big challenges that you will face in picking a mutual fund is the surfeit of choice available. Just look at the numbers. With over 40 AMCs, over 1,400 funds and more than 3,000 schemes on offer, you are truly spoilt for choice. Let us look at 10 smart tips to make the right choice of mutual funds.

10 tips to add solid mutual funds to your portfolio

1. First tip is that the past performance rarely fails you. Historically, good funds have given attractive past performance, seen over a period of time. Any mutual fund in its risk factors will tell you that past performance is not guarantee of future performance and that is true. However, it is seen in most cases that good funds manage to outperform in most market conditions. They certainly manage to outperform in the long run, when you factor in a period of 5-7 years.
2. Second tip is to look for funds that are consistent and boring. Yes, that is right. It is not just returns but consistency of returns that matters. Consistency is simple. A fund that generates 13%, 14% and 15% has given the same CAGR returns over 3 years as another fund that has generated 5%, -4% and 47% over 3 years. But, you don’t need to be a rocket scientist to know that the first fund is more consistent. Consistent funds earn good returns irrespective of timing of entry, so timing is not too important.
3. Third tip is whether the mutual fund fits into your long term financial plan or set of goals. The fund must be best for you in terms of returns, risk, liquidity and tax efficiency. The best funds are pointless if they don’t help you meet your goals. It is a good fund when it suits to your needs. That is why fund is a very individualistic selection and it must help you to meet your long term financial goals.
4. Fourth tip is to check how risky the fund is? What has been the risk associated with the fund. Earning 15% returns in an equity fund is great but what is the risk cost of these returns is the key question. A fund that generates 14% returns with 10% volatility is any day better than a fund manager who generates 16% returns with 40% volatility. That is where risk adjusted returns, come in handy. By that measure, the first fund is a lot better and safer too. You can figure out risk adjusted returns with Sharpe and Treynor ratios.
5. Is fund manager discretion good enough? Not too much of it is better. Prefer a fund that is based a lot more on process and rules that a fund that is based entirely on the discretion of the fund manager. The fund manager is human after all and prone to errors, biases and judgemental fallacies. If the fund manager is having full flexibility on everything, you are asking for trouble. That is hardly advisable.
6. Costs matter, whether you like it or not. For example, a 1% reduction in costs each year can make a valuable difference to you returns over a longer period of time. Remember, the total expense ratio or the TER gets debited to your NAV on a daily basis and hence lower costs means that returns will be higher. Equity fund TER will be more than debt funds, which in turn will have higher TER than liquid funds and ETFs. Within a category, focus on funds that have a higher AUM as it will lower the cost impact of TERs.
7. You cannot leave everything to the fund manager. You have to monitor your funds on a regular basis. Your job is not done with just putting your money into the fund. The concept of “Invest and forget” is not in your interest at all. That means; when you get the fund fact sheet each month check the fund manager commentary, the actual returns, the variance in returns, the portfolio mix etc. Poring over these finer points can give you a lot of insights.
8. You cannot leave everything to the fund manager. You have to monitor your funds on a regular basis. Your job is not done with just putting your money into the fund. The concept of “Invest and forget” is not in your interest at all. That means; when you get the fund fact sheet each month check the fund manager commentary, the actual returns, the variance in returns, the portfolio mix etc. Poring over these finer points can give you a lot of insights.
9. Know your cost of exit. It can be substantial in many cases. If the cost of exit loads plus taxes plus liquidity costs are too high then the basic purpose is defeated. Then there is the opportunity cost that is hard to quantify. You should be able to move out without a huge cost that would impact your net returns on the fund.
10. Always compare and think with your feet when funds consistently underperform. An occasional bad quarter is OK, not if you are consistently underperforming for a series of quarters in terms of rolling returns. You must create a mutual fund portfolio that has the right mix of equity funds, debt funds, liquid funds, variable funds etc. This mix needs to be tweaked consistently based on your changing needs and changing market conditions.