Mutual funds can be selected on various aspects such as risk appetite, financial goals, return expectation, investment horizon, tax-saving attributes, etc. on an investor’s part. When it comes to investing in mutual funds, an investor cannot try and decide what works best for them. This article serves as a guide on how to chooses a mutual fund. Following are some of the pointers that can help you to choose a mutual fund:
- Compare your scheme’s performance against the benchmark
Comparing your fund’s performance against a benchmark is always a good practice which should be embraced by investors. However, while comparing, ensure that you use an appropriate and reasonable benchmark. In short, the comparison should be an apple to apple comparison. Using the incorrect yardstick can fetch misleading data that can hamper your returns. For instance, for a large-cap equity mutual fund, the correct benchmark would be Nifty 50.
- Know your fund’s expense ratio
Expense ratio is defined as the annual fee charged by the asset management company (AMC) or the fund house for managing your mutual funds. As per the SEBI (Securities and Exchange Board of India), fund houses are not allowed to charge more than 2.5% as the total expense ratio. Expense ratios are charged out of returns received on mutual fund investments. So, the lower the expense ratio of a fund, the higher would be your take-home returns. Hence, make a habit to always check for the expense ratio of your mutual fund before finalising on it.
- Match fund history
A fund’s real worth is gauged only during unfavourable market situations, and a fund history is a testimony to that. Look for a scheme that has a fund history for a prolonged duration, say 5 to 10 years. Compare it across varying business cycles, time intervals, and market circumstances. For instance, a fund that has delivered a consistent performance in line with the expected returns during a market rally can be considered as a good investment option. Additionally, during a market slump, if it lost 8% returns while the benchmark lost 10% returns, then the fund has done considerably well.
- Compare risk-adjusted returns
Instead of factoring just annualised returns of the mutual fund scheme, consider risk-adjusted returns. As per risk-return trade-off, a higher degree of risk should be rewarded with a higher level of profits. The risk can be easily calculated with the help of a standard deviation. You can also use the Sharpe ratio that can help ascertain whether a particular fund is giving greater returns on every additional unit of risk undertaken. The fund that has a higher Sharpe ratio than the category average means that the fund manager has delivered higher returns for the extra risk taken.
It is always advised to invest in mutual funds after taking into account your risk profile, expected returns, investment horizon and financial goals. For instance, if you consider yourself as a risk-averse investor, you might consider investing in debt mutual funds. However, if you are looking for diversification, go for balanced funds- that provide you with the best of both worlds –equity and debt. There are different types of mutual funds available to cater to the varying needs of investors. Happy investing!