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How to Choose Mutual Funds in India

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Mutual fund selection can be done on several parameters like return expectation, risk tolerance, investment horizon, etc. on the investor’s part. The asset can be mapped across parameters like an expense ratio, past performance, fund manager experience, assets under management, etc. once you are through with your research, you will have a clear idea of where you would want to invest in.

Goals

When you invest in a mutual fund, your goal in terms of target date, time frame and a return expectations should be the starting point. In the absence of a clearly defined goal, you might be tempted to stop, exit or forget about your investment.

A goal can be short term like purchasing utility goods, down payment for a house or international holiday or long term like retirement or providing for college education of children.

Depending upon why you are investing in the given mutual fund, you will be able to rightly select the mutual fund type- debt mutual fund, equity mutual fund, hybrid mutual fund. For example, for some investors the main investment objective is to gain capital appreciation on their investments, for others, it may be tax saving. Depending upon what you are looking forward to, your fund selection will vary.

You can separate out your short term goals and long term goals and then select the right funds based on the time horizon to take a call.

Risk

Risk comes from not knowing what you are getting into’. Before choosing a mutual fund, the investor should analyze  the risk associated with the investment and if it aligns with the investor’s own risk profile.

Equity mutual fund investments are  subject to volatility and thus the portfolio might see ups and downs in the short term. Although, the returns can be substantially higher than other types of funds. These might be suitable for aggressive investors with a reasonably long time frame.

Debt mutual funds, on the other hand are more stable, but give lower returns than equity funds. These might be suitable for conservative investors. You can follow the table below to understand the category you  fall into based on the time horizon and your risk profile, to select the appropriate mutual fund for yourself.

Time Horizon/Risk Low Risk Medium Risk High Risk
Short Duration (up to 3 years) Liquid Funds, Ultra Short-duration Funds Short-duration Funds Arbitrage Funds
Medium Duration (3 years – 5 years) Short-duration Funds Balanced Advantage Funds Equity Hybrid Funds
Long Duration (5 years and above) Large Cap Funds Multicap Funds Mid Cap Funds, Small Cap Funds

Liquidity

Primarily, an investor should be able to ascertain as to when is the invested corpus needed.

If the money is needed in the near future, it should not be invested in equity mutual funds.

The money that can be put aside for a reasonably long period of time without worrying much about the market ups and downs should only be committed towards equity mutual funds.This is also important because compounding works best when money is left untouched for long periods of time. Hence, if you want to raise money for a short period, go for liquid funds.

Investment Strategy

Most investors ignore this aspect of investing in mutual funds but it holds a crucial place in the success of your investment portfolio. Investment strategy also referred to as the investment approach is the approach that the fund house adopts to make all the investments and holdings in the scheme. If the investment strategy of the fund house is not in line with your investment philosophy then a conflict of interest will arise out of the investment ultimately leading to you selling out your investments at undesirable prices.

Fund Performance

Fund performance matters, but not from a short term perspective of 6 – 12 months or even one or two years. It should be considered for a reasonable time frame. This is to ensure that the fund investments have gone through multiple market cycles and the returns have been consistent.In case the fund has not been able to beat its benchmark over three, five, seven or ten years, it is reasonable to believe that the fund might not be a good investment in the future as well. While evaluating a fund’s performance, it is important 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 proven track record would prove beneficial for investors.

Expense Ratio

The expense ratio is the commission or the fee charged from the investors for the proper management of their investments. It is basically the fund manager’s fee that is levied upon all investors for ensuring profits across the investments. As an investor, you must target mutual funds that have a lower expense ratio as the percentage may seem quite small but when it will be calculated across your total investment portfolio, it will have a deep impact. The expense ratio is a derivative of Assets Under Management and it is believed that the higher the AUM, the lower the expense ratio.

Entry And Exit Load

Entry load refers to the fee charged by fund houses from investors to start investing in their mutual fund scheme. Exit load refers to the fee charged by fund houses from investors upon exiting the mutual fund scheme. The entry load has however been removed by most fund houses; the exit load still remains.  There might be some conditions prevalent to exit load although like exit load will be levied only if the investor withdraws from the mutual scheme before a set limit.

As an investor, you must look out for mutual fund schemes that have zero or minimal entry and exit load.

Taxes   

Tax consideration is an aspect investors should look into carefully before investing in a mutual fund. As an investment vehicle, mutual funds are quite efficient in terms of post-tax returns. When equity fund units are redeemed, the returns so generated are taxed according to the period of holding and the applicable tax rate.

For equity  funds, Long Term Capital Gains (holding period of 12 months and above) are taxed at 10% over and above the exemption limit of 1 Lakh.

Short Term Capital Gains ( holding period of less than 12 months) are taxed at 15%.

For Debt funds, indexation benefit is available for capital gains realized.

(For these funds, a holding period of 36 months or more is considered as long term. Any holding period which is less than 36 months is treated as short term and the gains are added to the income of investors for tax calculation). So take the tax aspects of the fund category you are looking to invest in before you take a call.

Direct Plans 

There are two types of plans available for a mutual fund scheme-direct and regular. Direct and regular Mutual Funds are different versions of the same plan, wherein investors can directly buy required NAV units from a concerned asset management company in the first case, while the units have to be purchased through a commissioner or broker in case of the latter.  A key difference between direct Mutual Funds and regular funds  is that higher returns are usually generated in a direct Mutual Fund as no expenses are incurred as brokerage fees.

This commission varies between 1-1.25%, depending upon the asset management company and brokerage firm. In case of regular Mutual Funds, the concerned Asset Management Company (AMC) pays commission to the brokerage firm for increasing their clientele. This reduces the principal amount of investment, thereby reducing total returns generated .Needless to say, when we compare the expense ratios of direct mutual funds with that of regular funds, it is lower in case of the former as direct mutual funds do not have associated costs of brokerage.

Earlier when mutual funds were just introduced in India, going the regular route made sense due to lack of educational resources around the subject. However, now there are many platforms that offer you the necessary resources to make investment decisions by yourself and hence you need not be dependent on agents for advice and lose money on commissions.

To Sum Up 

Selecting a mutual fund is crucial to the overall success of your investment portfolio and achieving set objectives and goals. With so many options at hand, it is certain to get confused and land up in a tricky situation. Hence, keeping all the relevant factors in mind and mapping the target investment across them before making the final decision is the right move.

Happy Investing!
This article was published on groww.in and has merely been reproduced here.

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