One of the most common ways to select mutual funds is to invest with the crowd in today’s hot funds to achieve your future goal. Unfortunately, jumping from one winning mutual fund to another is a formula for disaster. The mutual funds that the crowd follows typically have had a hot recent performance and overlook to gather all the new mutual fund sales.
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Select a Mutual Fund
How to select mutual funds, is based on several parameters. These parameters include return expectation, risk tolerance, and investment goals. There are different parameters to consider for mutual fund selection including expense ratio, past performance, fund manager experience, and assets under management.
Once you, as an investor, do your research, you will have a clear idea about the funds in which you want to invest. And what type of category or funds. And then select a mutual fund based on that parameters.
Here we have given some parameters based on which you can select mutual funds for investments:
Identifying Goals to select the mutual funds
This is the basic to identify your goal. When you select the mutual funds, keep your target in mind. That is, what is the purpose of your investment. How long are you planning your investment and with what return expectations to achieve your goal?
Is your investment objective long-term capital gains, or is current income more significant? Will the investment be used to pay for college expenses, or to fund a retirement that’s decades away?
Identifying your goal is an important step in sculpting down the universe of more than 8,000 mutual funds available to investors to invest.
Depending upon why you are investing with a clear vision of your goal, you will be able to select the mutual funds’ type. It can be a debt mutual fund, equity mutual fund, or hybrid mutual fund specific to your goal.
Risk Tolerance
Risk comes from not understanding what you are getting into. Before choosing a mutual fund, You should also think about personal risk tolerance. And he/she has to check if can you accept theatrical swings in portfolio value? Or, is a more conservative investment more suitable for you?
Risk and return are directly proportional in the stock market, so you must balance your desire for returns against your capacity to tolerate risk.
According to your ability to tolerate risk, you can select these two mutual funds:
Equity mutual fund
These fund investments are subject to market fluctuations. Therefore, an equity-oriented portfolio could detect volatility as well in the short term. But remark that, the returns can be substantially higher than other types of funds. These types of funds might be suitable for long-term aggressive investors.
Debt mutual funds
These funds are comparatively more stable than equity funds. But the returns could be lower than equity mutual funds. These might be appropriate for conservative investors. Also, it can be suitable for a retirement plan, where you can not take more risks.
Liquidity
Investors should know when he/she may need the investment goal. That is, if the need is in the near future, it’s not for equity mutual funds because it is volatile and risky in the near future. Also, it may not provide the expected return. If you can stay with the investment for one year or more, then equity mutual funds can generate the anticipated returns.
Also, you may know that compounding works best when money is left untouched for long periods of time.
Also Read: What is the Power of Compounding in Mutual Funds
Investment Strategy
Most investors ignore this characteristic of investing. But it holds a crucial place in the success of your investment portfolio in any funds. An investment strategy is also directed as the investment approach. It is a strategy that the fund houses assume to make all the investment decisions. If the investment strategy of the fund house is not in line with your investment philosophy then a conflict of interest will arise and you may not achieve your goal. And finally leads to you exiting the investments at undesirable prices.
Fund performance
Fund performance matters in any investment fund. It should be evaluated for a reasonable time frame. This is to secure that the investments have gone through multiple market cycles. This would enable constant return over a period.
In case the mutual fund has not been able to beat its benchmark over three, five, seven or ten years, it is reasonable to believe that you have selected a bad mutual fund.
While evaluating any mutual fund’s performance, it is necessary to check the performance details of the fund manager or the fund management team. A strong, stable, experienced Fund management team with reasonable tenure and a proven track record would prove beneficial for investors to meet their objectives.
Expense Ratio
The expense ratio is the commission or the fee charged by fund management to the investors for the proper management of their investments. It is basically the fund manager’s fee that is charged to all investors for ensuring profits across the investments.
As an active investor, you must select mutual funds that have a lower expense ratio. This is because the percentage may seem quite small but when calculated across your total investment portfolio, it will have a larger impact over a long duration.
Entry And Exit Load
Entry load directs to the fee charged by fund houses from investors. Exit load directs to the fee charged at the time of exiting a mutual fund plan. This is chargeable only if investors exit within a short period (in general case within 1 year). This is to prevent quick exit and immediate outflow of cash from mutual fund houses.
Taxes
When you as an investor make money (returns) from your investment in any mutual funds, it is taxable as per Income Tax Act.
When equity fund units are redeemed, the returns are taxable as per the duration of holding, For equity mutual funds, Long Term Capital Gains (holding period of 12 months and above) are taxed at 10% over and above the profit gain limit of Rs 1 Lakh.
‘Short Term Capital Gains (holding period of fewer than 12 months) are taxed at 15% in all profit gain. For Debt funds, indexation advantage is available for capital gains realized.
Direct Plans
There are two types of plans available for a mutual fund strategy: direct and regular. Direct and regular Mutual Funds are different understandings of the same plan.
In the case of direct, investors can directly buy required NAV units from a concerned mutual fund house. In the case of regular, the NAV units have to be purchased through a commissioner or broker.
A fundamental difference between the two is that returns are a little higher in a direct Mutual Fund as no commission expenses are incurred. This commission ranges between 1-1.25%, depending upon the asset management company and brokerage firm.
In the subject of regular Mutual Funds, the concerned Asset Management Company (AMC) pays a commission to the brokerage firm for increasing their clientele. This lowers the principal amount of investment, thereby reducing total returns generated.
Alternatives to Mutual Funds
There are several significant alternatives to selecting a mutual fund, including exchange-traded funds (ETFs). ETFs normally have lower expense ratios than mutual funds, sometimes as low as 0.02%. ETFs do not have load fees, but investors must be mindful of the bid-ask spread.
ETFs also give investors easier access to influence than mutual funds. Leveraged ETFs are far more probable to outperform an index than a mutual fund manager, but they also increase risk. In ETFs, there can be a risk of liquidity during sales.
Conclusion
Mutual funds offer outcomes that can provide solutions for a large variety of financial goals, investment tenures, risk appetite and liquidity needs. If you consider the factors discussed herein, you will know how to select mutual funds in India. Evaluate all these aspects and make informed investment decisions before selecting the best mutual funds. You should always take the help of a financial advisor if you have hardships understanding the investment characteristics of any mutual funds.