Mutual funds have been the first choice for investors in recent years. They offer a way to start a disciplined investment journey through a monthly systematic investment plan (SIP) of ₹500, with a few fund houses requiring only ₹100 as the minimum investment amount.
When the market is down, you can buy more units, which offers you the rupee cost averaging. But the question here is, with so many options available in the market, which one should you choose? Keep reading to get the answer.
How to Choose the Best Mutual Fund?
To decide on the perfect fund, consider the following parameters to compare mutual funds:
Assess Fund Objective
Whichever fund you choose should align with your investment goal. For example, if you are approaching retirement and cannot afford to risk your savings, take a conservative approach and opt for a debt-oriented fund. Check the factsheet to see if the fund manager is managing the scheme with a wealth preservation, capital appreciation, or regular income generation objective.
A scheme with a regular income objective provides regular income through dividends. If you do not want to withdraw the dividend, you can reinvest it to buy more units.
Check Past Performance
Once you are clear about the investment objective, make a list of a few funds and compare their past performance. See how they have fared in different market cycles over the past 1 year, 3 years, and 5 years. Avoid a fund that delivers strong returns only in a booming market but lags during corrections.
Check which index the fund aims to compete with and whether it has outperformed it in the long run.
Evaluate Risk-Adjusted Returns
A fund delivering 30-35% returns comes with high risk. As such, it is important for you to read the risk-adjusted metrics like the Sharpe Ratio, Sortino Ratio, and Standard Deviation. A Sharpe Ratio determines how much risk you are taking to get an extra return per unit of your holdings.
The Sortino ratio factors in downside risk or negative volatility to measure the risk-adjusted returns. Standard deviation measures the volatility or spread of returns from their average.
For example, if the scheme returns are 10%, 12%, and 8% on the mutual funds screener, the average here is 10%. Since there is not much deviation in the returns, it will be considered a stable investment.
Assess Portfolio Composition
Go through the factsheet and see which stocks the portfolio holds. Check if the fund manager allocates capital across different sectors and market capitalisations. For instance, if the portfolio is heavily concentrated in the IT sector, or you choose a thematic fund focused on the IT industry, considering the current market scenario is important.
For instance, the trade conflict between India and the US could lead American companies to halt projects with Indian IT giants, causing a steep decline in your holding value.
Fund Manager’s Track Record
The performance of your portfolio depends greatly on your fund manager’s expertise. When deciding on a fund, compare the manager’s expertise not only in terms of the number of years but also their association with different asset management companies, the schemes they have managed, and the returns they have been able to deliver.
You must also check how often the mutual fund AMC changes the fund manager. If it is too frequent, there is a high chance of disruption in the investment strategy.
Check Liquidity
Mutual funds offer easy redemption. If you place a redemption request before 3:00 PM on a trading day, you will receive the net asset value of the same day. If the request is placed after 3:00 PM, the next day’s NAV is offered, provided it is not a holiday. Regarding the settlement time, the amount will be credited to your bank account in T+2 days.
While the redemption process seems smooth, some funds levy an exit load if you withdraw from your holdings before the specified period. Although the exit load is minor, it still eats into a portion of your profit, making comparison of this parameter important.
Expense Ratio
Compare the expense ratio of each of the shortlisted funds. It is the annual cost that the fund house charges for managing the scheme’s portfolio. Simply put, the expense ratio covers management fees, administrative charges, marketing and distribution costs, and custodian charges.
Now suppose there are two funds, named A and B. A levies a 1% expense ratio while B charges a 2% expense ratio. You invested ₹5 lakh in each. Both schemes have a track record of delivering 10% average returns in a year.
While in the span of a year, the difference in return due to this fee is only ₹5,000, over the course of 10 years, due to compounding, the difference will widen to around ₹90,000.
Conclusion
Picking the right funds for better returns is not tough. All you need to do is check the fund objective and see if it matches your goals, then review past performance and the risk-adjusted returns. You should also factor in the portfolio mix, the fund manager’s expertise, the expense ratio, and the tax implications.
The idea behind the whole comparison is to find a scheme that not only maximises returns but also minimises risks.