Mutual funds are amongst the many investment options available to an investor. Mutual funds are investment funds managed by a fund house. These funds are traded on stock exchanges and the money that is collected by way of issue of these funds is invested in other securities, the returns of which are paid to the investors. Mutual funds help investors in diversifying their portfolios and the professional management of these funds helps investors take advantage of any benefits and preventing themselves from potential losses in the stock markets. However, it becomes necessary to evaluate these mutual fund schemes objectively to invest money in the fund that will be most beneficial to the investor.
The following steps must generally be followed to evaluate and choose the perfect mutual fund
- Category of Fund
The first and the foremost choice of mutual funds involves the category of funds to be chosen. There are broadly these categories: Equity funds, Debt funds, Liquid Funds and Hybrid Funds. These categories must be analysed as every category has an associated risk, objective and maturity period, which must be matched with the preferences of the investor. After the category of funds has been chosen, the next step is to analyse the objectives of various fund schemes within that category.
Every mutual fund is formed with a pre-determined objective. These objectives can be capital appreciation or regular income. Thus, an investor investing in these funds for speculative purposes should go for a fund that focuses on capital appreciation, whereas a household investing in a fund with the aim of getting a sum of money regularly, must invest in those funds, whose objective is to generate regular income. The investment strategy and the benchmark set by the fund scheme should also be taken into account. The fund manager will have a predetermined strategy to invest the fund in a number of securities. The investor of a fund must have knowledge of where the money of the fund is being invested in. After the funds have been shortlisted, their expenses ratio must be calculated for further filtering of funds.
- Expenses Ratio
Owning a mutual fund involve various expenses like sales load, exit load, mutual fund management fee, office leases, analyst salaries, etc. These expenses can eat away earnings even before they reach the investor. Thus, investors must always go for a fund with a lower expenses ratio. However, not only the expenses ratio, but the turnover rate is also significant in choosing the fund.
- Turnover rate
Turnover rate refers to the number of times a fund is bought and sold. A higher turnover rate not only leads to higher transaction costs, but also generates taxable gains. Thus, the investor will end up paying more taxes than on a fund with a lower turnover rate.Thus, investors must always go for a mutual fund with a lower turnover rate.
After the above analysis has been undertaken, its important to figure out whether there is a need to diversify or not and whether the investor must go for an index fund or an actively managed fund.
Whether an investor must diversify or not depends on his risk tolerance and knowledge of investing. If the investor does not have a lot of knowledge about economic sectors and markets and his risk tolerance is low, he must diversify his funds across different sectors to lower risk.
- Index Funds vs. actively managed funds
Index funds are those mutual funds which tracks market indexes. They are known to provide a broad market exposure, low turnover rate and low expenses ratio. Past performances have revealed index funds perform better than actively managed funds. Index funds rise and fall with the market, but actively managed funds may even rise when the market falls depending upon the decision taken by the fund manager.
In the current scenario of a depreciating rupee, the industry experts are vouching for the investors to keep a 12 month period in mind in case of short term investments and an 18 month period in case of long term investments to beat volatility in the markets.