Hi Readers. One of the most frequently asked question by our blog readers is how to select right mutual funds to invest in.
Although mutual funds are managed by professional managers, however, not all funds perform are equally well. There are many funds who are not even able to beat the index. That’s why it’s really important for you to select right mutual funds that will fulfill your investment goals.
While researching the best mutual funds to invest, most beginners just look at the past performance. However, two equally other important factors to be checked before selecting any fund is whether the objective of the fund matches your investment goals and what are the different risks associated with the fund.
Moreover, mutual fund investing is a long-term relationship. Unlike the direct investment in stocks, where the people can switch the stocks fast, mutual funds are a long time period commitment. Most people stick with their funds for over 8-10 years. Therefore, it’s important that you choose a right fund and not get stuck with lagging ones which might result in you to lose both time and money.
In this post, we are sharing a beginners guide to select right mutual funds in seven easy steps. This guide will help you to perform exact step-by-step research to find winning mutual funds. Let’s get started.
Here are the seven essential steps to select right mutual funds that will help you to meet your investment goals.
1. Read the Offer Document Carefully
One of the most comprehensive documents that every mutual fund provides is its offer document (also known as the prospectus). The first and probably the biggest step while choosing a mutual fund is to read the offer document carefully.
The offer document contains all the important details regarding the mutual fund like its objective, scheme type, past performance, details about the asset management company, classes of the underlying assets etc. (Quick note: If you are not familiar with these terms, check out this post regarding the must-know mutual fund terms). There is a strict instruction by SEBI regarding the filling of offer letter offered by the mutual funds- which you can find here.
In short, begin your research by reading the offer document of the mutual fund. Moreover, it’s not really difficult to understand these documents.
2. Match the objective of the fund with that of yours.
Every mutual fund has a specific objective. And based on the objective, they decide different factors like asset allocation (equity to bond weight), risks, dividend payouts, tax benefits, theme/sector focus etc.
You need to read the offer document of the fund and attentively identify whether the fund objectives meets your investment needs in terms of the above-mentioned factors. If the objectives are not relevant to you, then it might not be a good option to invest in those funds w.r.t. your investment goals.
3. Check Fees and Exit Loads
Mutual fund charges a fee for offering services and to meet different expenses like manager’s fee, operational & administration costs, advertisement costs etc. Generally, this expense ratio for an active fund can be as high as 2-2.5%. Further, some mutual funds may also charge you a fee up front when you invest (entry load), or a deferred sales charge when you sell your shares (exit load).
These pieces of information are present in the offer letter of a mutual fund. As a value investor, you should try to stay away from mutual funds with high fees and loads to avoid unnecessary costs.
4. Evaluate the past performance of the fund
Although the past performance of a fund will not guarantee how well it will perform in the future, however, it will give you a rough idea about the returns and expectations. This is certainly an important factor which must be checked. Moreover, you should compare the funds’ past performance to the benchmark as it will give you a better idea of its actual performance.
You can easily find the information regarding the past performance of any fund vs the benchmark on the financial websites like ValueResearchOnline or moneycontrol. Further, focus on the long-term performance (3 years or greater) and compare it with its competitors and index.
5. Analyze portfolio and holdings
This may be a little tricky for those who have zero knowledge of investing. After all, even if you find out which companies that mutual fund is investing in, how will you understand whether the holdings are good or bad?
Nevertheless, analyzing the portfolio and holdings gives you a general idea about the securities in which the fund is investing. Here, the key point is to make sure that the fund is investing in the type of securities in which you are interested. For example- if you are optimistic about electric vehicles and want to invest a major proportion in the automobile sector, look for a mutual fund which has a high percentage of allocation in the automobile sector. Similarly, if you’re interested to invest in other sectors like energy, infrastructure, finance etc- then studying the portfolio will give you a good idea whether the fund is right for you or not.
Anyways, there is also another trouble in while analyzing the portfolio and holding. The portfolio/holdings can change from time to time as the manager may decide to buy or sell securities at their will. Therefore, if you are not regularly reviewing the fund, the current allocation might be a little different from the time when you invested in the fund. That’s why you should always review your fund every six months or a year after purchasing to confirm that your requirements are still met by the fund.
6. Check the Tenure of Fund Manager
The fund manager is probably the heart of the mutual fund. He/She is the one who will be making all the important buy/sell decisions on your behalf. Therefore, it’s important to find out more about the fund manager.
A manager with a long tenure may have done the job well and his/her credentials are tried out. On the other hand, the efficiency of a new manager might not have been tested yet. While researching mutual funds, check the tenure of the fund manager to find how long this fund manager is managing the fund.
Another important factor regarding the fund manager is to check which other funds he/she is managing. If the other funds are also doing equally good, then it is a good sign. On the other hand, if just one fund is performing well- while the other funds that he/she is managing are struggling, then it might be a fluff.
7. Check the size and credentials of the fund house
Although it’s not the biggest factor, however, as an intelligent investor- always invest in the fund which has already established a good track record. It’s important that the fund house has strong credentials because mutual funds investing is a prolonged relationship and you do not want to get involved with a troublesome fund house which might give you headaches in upcoming years.
Nevertheless, in a few scenarios, you may invest in comparatively newer plans or fund houses. For example, if there is an exciting new theme based fund house that meets your asset allocation plan, then feel free to invest a small amount in it and later increase the amount depending on the performance.
Quick Note: If you are new to investing and want to learn how to invest in mutual funds from scratch, check out this amazing online course: Investing in Mutual Funds- A Beginner’s course. Enroll in the course now to start your journey in the requisite world of investing today.
The procedure to select right mutual funds to invest requires a careful study of the fund. In this post, we have covered the seven critical factors that you need to check to select right mutual funds to invest.
Besides, you might have noticed that we didn’t talk about the ratings of the fund. This is because of the reason that the ratings vary from websites to the website. It’s quite rare that you’ll find the same fund listed in the top 10 suggested mutual funds on different financial websites. Which one to trust? Better make your own decisions. Anyways, if you’re really interested to check the ratings, then the CRISIL ratings may be a little helpful.
Here is the final tip- Do not rush with investing. There are hundreds of mutual funds in the Indian market. Take your time to analyze them and find out the one that best suits your goals.
That’s all for this post. I hope it was helpful to you. Happy Investing.