Twitter
Advertisement

How to pick the right mutual fund

Choosing between debt and equities and deciding when to invest are challenges that every new investor faces before putting money into the stock market

Latest News
article-main
FacebookTwitterWhatsappLinkedin

Most millennials today are keen on investing in mutual funds. Their understanding of mutual funds stems from engaging in punchlines like "Mutual Funds Sahi Hai". This investor education initiative by the Association of Mutual Funds in India (AMFI) ensured increased investments in myriad mutual funds. While some investors were financially literate and entered the market only after studying its pros and cons, others relied on the judgment of financial experts or hearsay.

While it is true that investments in equities have earned good returns in the past, the famous adage "past performance is not an indicator of future outcomes" holds for mutual funds too. This is because risk accompanies returns in mutual funds, especially, when invested for a short tenure. However, for those newly investing in the equity fund market, choosing the right fund is difficult as it involves a lot of factors that they may be unaware of.

Determining your financial goal

To know which funds, when invested in, would help you to achieve your financial goals mandates prior knowledge of the latter without which no investment decision can proceed. Radhika Gupta, CEO, Edelweiss AMC, says, "Every investment instrument you choose should be tied to a financial goal including mutual funds. Goal-based investing is more so important in mutual funds since it will help you to choose the right scheme according to your risk appetite and the time-frame you have set to achieve it. In the end, your fund should be compatible with your financial goal. Though mutual funds have generated good returns over longer time frames, past returns cannot be an indicator of future returns. Hence, setting a goal will not only help you keep track of your progress, but also influence you to make a prudent choice without getting anchored to past returns."

INVESTMENT RISK

  • Goal-based investing is more so important in mutual funds since it will help you to choose the right scheme according to your risk appetite and the time-frame you have set to achieve it
     
  • Your mutual fund investment might be offering negative returns now, but that shouldn’t make you redeem your units. Instead, increase your investment to buy more units at a lower cost, and you can redeem them when the markets hit their peak

Know your risk appetite

"How much risk do you want to take?" is a question that you must ask yourself before jumping headlong into the world of equities and debts. Returns come at the cost of risks, which means that you cannot ignore the risk factor involved while envisaging your fund returns.

Those investing for a short duration must opt for funds with a conservative outlook. Such funds consider more of debt and fixed return instruments than equities that must be chosen only when you are ready to stay invested for prolonged periods, say 10-15 years. Deepak Chellani, Head of Third-Party Products, Prabhudas Lilladher, says, "One needs to think of capital preservation and safe investments. The risk in equity cannot be eliminated but reduced. In volatile markets, there are two options one can either look at investing in purely conservative debt instruments, e.g., accrual debt funds like ultra short term, short term, liquid & money market funds. Funds in these categories don't have interest rate risk, unlike the dynamic bond funds and credit risk funds. Their average maturities are of shorter-term and hence one can look at them as an investment option and then invest into equity with a long-term view in a staggered manner. So, to summarise, whether one who is conservative definitely would invest into conservative mutual funds in the shorter term to avoid market and interest rate volatility."

Managing risk

Depending on how much risk you can bear or the extent of earnings you want to earn from the market, you may choose between equities, liquid funds, short-term debt funds and balanced funds. Returns of most debt funds are mostly identical, which means that you are left to manage the inherent risk than paying attention to returns generated. Rajeev Srivastava, Head-Retail Broking, Reliance Securities, says, "Debt funds bear interest rate risk, credit risk and concentration risk. This has a huge bearing on the bond price and NAV. If the credit call goes wrong, the debt fund will have to write off the principal amount and the interest, which we have seen in the recent NBFC default that has eroded the investment of investors and therefore one needs to keep a tight check on risk management rather than only on interest rate returns. Debt funds should only be short-term to medium-term of three to four years and keep reviewing it every quarter."

Consistency matters

How long your choice of the fund has been performing in the market or has it managed to stay stable in the face of market volatility helps determine the consistency with which your fund has been performing. Archit Gupta, founder and CEO, ClearTax, says, "Investing with a long-term horizon mitigates market volatility by offering the benefit of rupee cost averaging. Your mutual fund investment might be offering negative returns now, but that shouldn't make you redeem your units. Instead, increase your investment to buy more units at a lower cost, and you can redeem them when the markets hit their peak to make good profits."

Check the track record of your fund manager

Experience of fund managers matters while their knowledge about the market and its potential movement cannot be ignored. Any fund sinks or rises, thanks to the business acumen of its manager, thus, implying the need to check the track record of the fund manager over the past decade before investing. Arun Kumar, Head of Research, FundsIndia.com, says, "Check the performance across a complete market cycle, i.e., a period between two peaks covering a bear market, recovery and the bull market. Check consistency in outperformance by evaluating the percentage of times the fund manager has outperformed the benchmark over three-year rolling return periods in the last seven years. The downside capture ratio and maximum draw-down also give a fair sense of the risk taken to produce the returns."

Find your daily dose of news & explainers in your WhatsApp. Stay updated, Stay informed-  Follow DNA on WhatsApp.
Advertisement

Live tv

Advertisement
Advertisement