Topic 3: Six steps to shortlist the right mutual fund
Understanding the merits of investing in mutual funds is one side of the story. What is more important is to ensure that you find the right fund. Be it equity, debt or balanced funds, you need to have a clear cut process to identify the funds.
Here are six steps to identifying the right fund:
Sync with your goals
Evaluate each fund from the perspective of your own goals. These can be long term goals, medium term goals or short term goals. Check your risk appetite, your risk capacity and your return requirements. Also focus on your tax status and liquidity needs. In case of long term plan, ensure that liquidity is available easily around the milestones.
All about diversification
The primary job of the fund manager is to diversify your risk exposure. This applies to equity funds as well as debt funds. You need diversification across sectors, themes and capitalization in equity funds. You need diversification across duration and credit quality in debt funds. While diversification is seen as a method to reduce your overall risk, it can also provide you with multiple opportunities that you may have otherwise neglected.
Consistency of performance
This is the cardinal rule when you select a mutual fund. You must prefer the fund that gives you consistency. You can check the consistency of the funds’ performance by evaluating it on quantitative parameters such as historical performance and performance vis-à-vis benchmark/peers and by qualitative parameters such as portfolio quality and quality of fund manager/house.
Your fund manager
The most basic measure is the out performance of the fund over the benchmark index. Also, look at the risk taken. If the fund manager has outperformed the benchmark by taking on too much risk then it means your fund manager is compromising your interests. Also, beware of fund managers who rely too much on the market to outperform.
Expense ratios
Irrespective of whether you are investing in an equity fund or a debt fund, compare the total expense ratio (TER) with peers and select the fund that offers performance with the lowest TER. If two funds have expense ratios of 0.50% and 1.5%, respectively, the latter has a much bigger hurdle to beat before money starts flowing into your pocketbook. Over time, these seemingly small percentages can result in a huge difference in how your wealth grows.
Size and pedigree
Return rankings of mutual funds may show out performance by smaller funds, but you must stick to larger funds that have been around for 15-20 years. Larger funds with bigger AUMs are likely to stay on in the business for the longer term. Always invest in the fund which has already established a good track record. Prefer size and pedigree when other factors are taken care of. This test will form the cornerstone of your mutual fund selection. You can still go wrong, but you have at least created a framework for scientific selection of funds. What matters in the final analysis is not how good or aggressive the fund is. What really matters is how well the fund fits into your goals and how it helps you achieve your goals with minimal risk.
Sync with your goals
Evaluate each fund from the perspective of your own goals. These can be long term goals, medium term goals or short term goals. Check your risk appetite, your risk capacity and your return requirements. Also focus on your tax status and liquidity needs. In case of long term plan, ensure that liquidity is available easily around the milestones.
All about diversification
The primary job of the fund manager is to diversify your risk exposure. This applies to equity funds as well as debt funds. You need diversification across sectors, themes and capitalization in equity funds. You need diversification across duration and credit quality in debt funds. While diversification is seen as a method to reduce your overall risk, it can also provide you with multiple opportunities that you may have otherwise neglected.
Consistency of performance
This is the cardinal rule when you select a mutual fund. You must prefer the fund that gives you consistency. You can check the consistency of the funds’ performance by evaluating it on quantitative parameters such as historical performance and performance vis-à-vis benchmark/peers and by qualitative parameters such as portfolio quality and quality of fund manager/house.
Your fund manager
The most basic measure is the out performance of the fund over the benchmark index. Also, look at the risk taken. If the fund manager has outperformed the benchmark by taking on too much risk then it means your fund manager is compromising your interests. Also, beware of fund managers who rely too much on the market to outperform.
Expense ratios
Irrespective of whether you are investing in an equity fund or a debt fund, compare the total expense ratio (TER) with peers and select the fund that offers performance with the lowest TER. If two funds have expense ratios of 0.50% and 1.5%, respectively, the latter has a much bigger hurdle to beat before money starts flowing into your pocketbook. Over time, these seemingly small percentages can result in a huge difference in how your wealth grows.
Size and pedigree
Return rankings of mutual funds may show out performance by smaller funds, but you must stick to larger funds that have been around for 15-20 years. Larger funds with bigger AUMs are likely to stay on in the business for the longer term. Always invest in the fund which has already established a good track record. Prefer size and pedigree when other factors are taken care of. This test will form the cornerstone of your mutual fund selection. You can still go wrong, but you have at least created a framework for scientific selection of funds. What matters in the final analysis is not how good or aggressive the fund is. What really matters is how well the fund fits into your goals and how it helps you achieve your goals with minimal risk.