Investors are often puzzled when it comes to investments in mutual funds as there are plenty. All funds come with their own sets of pros and cons but all investors have varying objectives and requirements and they should invest as per their investment goals. But before you begin to invest, you first need to decide on the category of mutual funds, that is, whether you want to invest in equity, debt, or hybrid funds, and what would be their respective sub-categories. Then, you may choose among a variety of funds based on certain parameters. In this blog, we shall discuss the major factors that an investor must consider before investing money in it.
What should you Consider before Selecting a Mutual Fund Category?
Mutual funds have been categorized as per the norms laid by the Securities and Exchange Board of India (SEBI). All the fund houses or Asset Management Companies (AMCs) must launch mutual fund schemes in all categories as per the SEBI regulations. You can choose from a plethora of MF schemes but first, you need to decide the category that can match your investment purposes. Consider the below factors:
1. Identify Your Investment Goals
Know your investment goals, i.e. identify whether you seek growth or value. You should invest in equity funds or aggressive hybrid funds if you want high returns. But these funds also come with high risks, so if you would want to park your money somewhere which is not easily influenced by market volatility, then you should consider bond funds. You should plan out your objectives, like whether you want to have a retirement fund, fund children’s education or wedding, have an emergency fund for urgent requirements, medical expenses or other mishappenings, etc.
2. Time Horizon
Investment goals and time horizons go hand-in-hand. You can actually set your objectives as per the time duration you want to stay invested for. Long-term goals allow you to focus on growth-oriented equity funds, as you can have ample time to ride through the upheavals of the market, for example – retirement funds. Mid-term goals should have a balanced portfolio of growth and value funds that provide good returns and stability against market volatility.
Investors with short-term goals should invest about 30% of their money in bond funds so that market ups and downs do not have a negative impact in the near-by term. For example, if you want to plan a short-term fund for college expenses. You should be able to have your money whenever you want it and hence, you should invest in funds that are easy to redeem. Also, you can invest in Income funds to have a regular income.
3. Risk Tolerance
One of the major factors to consider before investing is to measure your risk tolerance, meaning that you should evaluate whether you wish to play safe or take some risks and whether you have a high-risk tolerance or moderate risk appetite. Based on your risk tolerance, you can bear the market volatility and choose the funds to invest accordingly. Risks and returns are directly proportional, so know if you want to take an aggressive route or have a conservative approach towards your mutual fund investments.
If you are an investor who wants to take high-risk in exchange for a high return, then you should go for equity funds, especially mid-cap and small-cap funds. Large-cap funds, for instance, are comparatively safer while hybrid funds give a mix of stocks and bonds. Debt funds, on the other hand, offer further stability. Since each fund offers a different variation of risk and return, you should do a proper risk analysis of the funds before you invest in them.
So, investors should draw a financial roadmap to evaluate their risk-taking abilities before choosing the fund category.
Factors to Consider Before Choosing a Mutual Fund Scheme
First and foremost, investors must understand that choosing the category and the scheme of a mutual fund are two different things. Plenty of mutual fund schemes can exist in one mutual fund category. Investors should decide on the category as per the factors mentioned above and then consider the below-mentioned factors to opt for a mutual fund scheme:
1. Fund Performance
Investors should consider the fund performance of the mutual fund scheme before investing. Compare the 3-5 year performance against the benchmark as well as the category of the fund along with the consistency of the performance. The asset allocation of a fund should match the benchmark index, that is, they must have similar objectives. For example, small-cap fund schemes will be compared against a small-cap benchmark. Similarly, you should compare with other schemes in one fund category. Benchmark indices are the standard against which a fund’s performance, and the asset allocation, are compared.
2. Net Asset Value
Net Asset Value (NAV) refers to the market value per unit of mutual funds and is often a key factor for many investors. Mutual funds with high NAV are expensive and can also offer lesser growth whereas the ones with lower NAV cost less and give more growth opportunities. However, sometimes a mutual fund with a higher NAV may invest in quality stocks and bonds to give good returns to investors and hence, can be more reliable than mutual funds with a lower NAV. Therefore, while the NAV is important, it cannot be the deciding factor for investment in any mutual fund scheme, so you must consider the other parameters as well.
3. AMC Performance
Investors should check the performance of AMCs just like they check the fund performance. All fund houses have plenty of schemes under them, and some investment decisions are made at the AMC level. For instance, you may find certain stocks in most of the schemes that were selected by the CIO (Chief Investment Officer) at the AMC level. Some funds may underperform but the overall track record of an AMC matters the most. It reflects the investment decisions that are made and how fund schemes may perform in the future.
4. Expense Ratio
All funds come with some costs and fees, which include managerial and operational charges as mutual funds are schemes managed by professional individuals. Fund managers research, analyze and do timely investments and withdrawals from stocks and bonds to generate good returns on behalf of the fundholders. These are the charges for management, promotion, administration, and distribution of a mutual fund. Most expense ratios are somewhere between 1-2% and some of them are lower than 1%. It is important to check the expense ratio as even the slightest difference can impact your wealth growth significantly. The Securities & Exchange Board of India (SEBI) has capped the expense ratio at 2.25% of the total fund assets by capital markets that an Asset Management Company (AMC) can charge.
5. Exit Load
Just like the expense ratio, some funds also have an exit load if you make a premature exit from the fund. So, you must check if the schemes have any exit load or they are free from it.
6. AUM (Assets Under Management) of the AMC
AUM (Assets Under Management), as it indicates, is the total assets that are being managed by a mutual fund scheme. A larger AUM indicates a larger fund corpus from the collection of funds from investors and also indicates that more investors are involved. A larger AUM for equity funds makes it tough for the fund to enter or exit the companies but it is favorable in the case of liquid funds or other short-term debt funds.
7. Experience of the Fund Manager
SEBI has mandated all AMCs to declare the asset allocation as well as the details of the fund managers. It is advised that you check the qualifications and experience of the fund managers, what funds they have managed and how those funds have performed, etc. You should know if the fund managers could deliver the results outperforming the benchmark indices or matching them before you decide to invest in a fund managed by a particular fund manager. Also, note that if the returns were consistent or more volatile than market indices. The management of the fund should also be taken into consideration, whether they are actively or passively managed. At times, the longevity of the fund managers on a scheme also matters, because if a fund is performing well, then fund managers will stick to it.
Wrapping it up:
Mutual funds selection is a two-step process, selecting the category and then the scheme, suiting the individual’s goals and risk appetite. Checking the fund type, its performance, track record of the AMC, and that of the fund managers are a few factors you must keep in mind. Also, check how much the scheme loads on you through its operational fees and exit charges along with the volatility of the scheme. Additionally, tax implications of all categories of funds, depending on the long-term or short-term gains must be borne in mind before investors arrive at a decision.