How to select the best Mutual Fund ?
People generally invest in those mutual funds which are suggested to them by their friends or family members, which is not a good strategy. In fact, investing in any mutual fund based on its ranking or stars on some random website is a poor approach too. You have to understand that a mutual fund is a very vast terminology, under which there are so many different types of funds with different risk, returns, maturity, expenses, etc. and therefore a fund which is perfect for your friend to achieve his financial goals, might not be good for you. But don't worry, here is a checklist on how to select the best mutual fund, as per your personal financial goals.
Risk is the first thing that every investor should know before investing, the amount of risk that you are able and willing to take will help you in shortlisting the mutual funds. On a macro level, mutual funds are of two types - Equity Mutual Funds and Debt Mutual Funds and there is a common myth among investor that debt funds are risk-free. So first, get this clear, Debt funds are not a risk-free investment and to prove it, we have the most recent examples of all those debt funds who had to take a big hit because of their exposure to the ILFS Bonds, DHFL Bonds, etc. Hence debt funds have a lower risk but they are not 100 risk-free.
So, before you select the best mutual fund, you should know your age, income, retirement, financial goals, etc and then select accordingly. For eg, if you are very young let's say in your 20s with a decent income and wants to save for your retirement, then you could take higher risk compared to a person who is in his late 50s. So, your investment should be more in equity funds and you can even invest in small-cap funds whereas his investment should be more in debt funds and that too in funds which invests in investment-grade bonds.
2. Time Horizon
Next thing you should consider while selecting the best mutual fund is your investment time horizon. If you're investing for let's say 8-9 years or more than you can consider equity mutual funds. But there are some investors who invest for 6 months or a year, for them the equity mutual funds will be a very risky option and they are generally suggested to invest in some liquid funds.
3. Market Expectation
If you are expecting a lower growth in the overall equity market for the next few months or years, then currently you can start your investment with debt mutual funds and later when you realize that the equity market has started improving then you can gradually switch your investments to equity mutual fund.
4. Asset Under Management
Asset Under Management or AUM is simply the total invested amount managed under a particular fund and there has always been a debate among investors on this topic. Some believe that investing in a fund with a very high AUM gives you access to more expert fund managers, who have more experience and also the overall expense ratio to manage such funds are comparatively lower. On the other side some believe that as the AUM becomes too large, their overall capability to generate excess return called alpha decreases because of two reasons-
- Generally, the funds are not allowed to keep ideal money up to a certain limit and hence they have to invest even if they don't find any good opportunity.
- When the fund invests in a lot of securities because of high AUM, then it generally starts representing the market, with the almost same risk and return.
Hence, it is suggested, not to invest in too big and too small funds. Rather you should invest in a mid-size fund.
5. Expense Ratio
Expense Ratio is a percentage of your total return which is deducted by the fund houses as their fees, taxes and other related costs. This ratio varies according to different funds and can range between 0.5% - 1.5%. Most of the investors ignore this expense ratio, considering it a very small percentage and it is not too important, but in the long run, this small percentage takes away a large chunk of your total return. So, until you don't think that the higher expense ratio charged by a particular fund is justified, don't invest in those funds. Hence it is better to consider the expense ratio while selecting the best mutual fund for you.
6. Historical Performance
You should consider the fund's historical performance before investing in it. How the fund has performed in the past can give you an idea about the future. But, don't look its short term return i.e. for 3 months or 6 months. Rather, observe how the fund has performed in the past 3-5 years. To get a better idea about how the fund has performed, you can compare its return with the return of its benchmark and its category. '
Also, one thing to note is who was the fund manager at the time when the fund performance was good and whether he/she is still continuing or the manager has changed. If the fund manager has changed, then its historical returns doesn't give you fare idea.
There are many other factors which answer the question of - how to select a best mutual fund. To see a complete list of best mutual funds under different categories click here and to see the parameters we have considered while selecting these mutual funds, click here.