Often, investors solely start investing based on returns or after being recommended by a friend. This approach may feel reasonable at first glance, but those who take investments seriously consider a different approach altogether. They take time comparing mutual funds based on various parameters they feel are relevant.
After all, not all funds serve the same purpose, even when their returns look similar. You might even find two mutual funds with comparable returns behaving differently when markets come under stress.
The goal of comparing mutual funds before you invest is not to predict the winner. It’s more about reducing risks that can actually be avoided. Ultimately, you would like to invest in a fund that fits your investment goals. Here, we have discussed the importance of comparing funds and how investors should go about it.
Why should you not invest without comparison?
The key factor of investing without comparing mutual funds is accepting risks unknowingly that you do not take into account.
1. Choosing the wrong fund
A fund mismatch in the portfolio is one of the most common issues. Investors often end up choosing a fund with volatility or a strategy that doesn’t suit their personal comfort levels. As a result, they sometimes sell off the units in panic when markets correct, even when the long-term prospects remain promising.
2. Overlapping portfolio
Unless you compare mutual funds, your portfolio may include multiple funds that invest in the same stocks or sectors. This can lead to concentration, preventing diversification. During downturns, your portfolio looks fragile.
3. Cost blindness
You may not notice the expense ratios of the mutual fund you are choosing. Over time, this keeps eroding your wealth.
What does fund comparison mean?
Fund comparison involves understanding the performance of two or more mutual funds based on specific parameters. These include:
· Consistency of returns
Based on these aspects, investors should evaluate:
· The risks involved in their approach
· Whether they suit their investment goals
Therefore, fund comparison is more about alignment, not prediction.
So, when you compare mutual funds, evaluate how they invest. The process examines:
· Whether a fund prioritises growth or stability
· How concentrated its portfolio is
· How it performs across different market cycles
For instance, you may examine two equity funds of the same category. However, they may widely differ in terms of volatility and downside protection. One may be suitable for aggressive investors, while the other may be ideal for conservative portfolios.
Through mutual fund comparison, investors can determine whether or not to include a specific mutual fund in their portfolio on the basis of their goals, time horizon, and risk tolerance.
Key parameters investors should compare
When you compare different funds, weigh their performance or profile based on these crucial parameters.
1. Investment goals
Investors often overlook the goal of the fund they invest in. Firstly, identify whether it aims for capital appreciation, generating stable income, or tax efficiency. Accordingly, you can choose one that fits your financial goals.
2. Risk and volatility
There’s little to take solely from return figures unless you get to know the volatility the fund went through. Compare volatility, drawdowns, and risk-adjusted performance, so that you get a comprehensive understanding of how a fund behaves when markets are down.
3. Consistent performance
Investors can hardly get any idea about the quality of a fund from one-year results. Try to evaluate their performance across multiple market cycles. This will help you gain a detailed insight into the financial discipline of the fund managers.
4. Expense structure
If you’re investing for the longer horizon, costs matter. Compare the expense ratios of mutual funds within the same category. This will help you retain more of your returns over time.
5. Portfolio composition
Take a look at the portfolio composition. This includes exposure to specific sectors, stock concentration, and overlap with your existing holdings.
Comparing funds across different categories
Often, investors end up choosing the wrong fund simply because they evaluate their performance based only on returns. However, you need to look at the fund category and determine whether it suits your portfolio.
For instance, some funds, like small caps or certain thematic funds, are designed for aggressive growth. Others are meant to stabilise your portfolio. So, if you compare mutual funds simply on the basis of their returns, these differences get overlooked.
For example, investors prioritising tax efficiency may evaluate ELSS mutual funds. In these situations, they must also look at the lock-in periods and tax alignment.
Likewise, index funds may suit your portfolio if you prioritise efficiency and cost through passive fund management without trying to outperform the market.
With category-wise comparison, you can also include funds that complement each other in your portfolio to improve balance.
How fund comparison improves portfolio outcomes
A careful fund comparison reduces overlaps and improves diversification. Each fund is supposed to play a specific role over different time horizons. With clarity, investors can properly balance their portfolios.
As an investor, you must understand why you should hold a particular fund. This implies you’re less likely to react emotionally to short-term underperformance. Proper mutual fund comparison also helps you set realistic expectations. This eventually prevents disappointments stemming from using strategies that don’t suit your financial habits.
A disciplined approach to fund comparison and selection works wonders over time. Most importantly, you can protect your portfolio from poor choices.
Conclusion
Now that you understand why fund comparison is important, take time to evaluate potential picks before you compose your portfolio. It’s not an optional step before you invest. In fact, fund comparison is a foundational skill for investment, which helps you make informed decisions and manage risk consciously.
The market will continue to fluctuate. However, when you pick your mutual funds with a stringent approach, you stay invested with confidence even through rough patches.
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