Investment options can be confusing because of the sheer number of choices. While some people prefer safe and traditional means to save money like pension schemes or provident funds, there are many who don’t mind taking a certain amount of risk, and invest in mutual funds. But it is wise to understand a bit more about mutual funds before you make your decision. There are more than ten-thousand mutual fund management firms that you could choose from, so awareness about them will go a long way in making the right decision. A lot depends on what your needs are and what is the final objective or goal. It is important where you choose to invest your money, and you should know what a smart investment is. We discuss mutual funds in detail so that you can make a more informed decision and understand how to pick a mutual fund.
What Are Mutual Funds?
Mutual funds refer to pooled money accrued by a pool of investors who aim at saving and earning thought their investments. The corpus of monies so formed is then invested in a variety of assets like debt funds and liquid assets. There are different types of mutual funds based on structure, the objective of investing, and asset class. Picking a good mutual fund option is all about investments that provide good yields at low costs. They shine more when they strategically augment your portfolio and financial objectives.
10 Tips to Select the Best Mutual Fund
Certain tips on how to choose mutual funds for beginners can help you analyse the funds and strategise before you arrive at your decision.
1. Know Your Goal and Your Risk Tolerance
It is important to be aware of your goal and objective behind investing in a mutual fund. Understand the answer to the following questions about the goal, the risk tolerance, and the timelines-
- Do you want current income or are you looking at long-term appreciation?
- Is there a specific use like a college fund or plain retirement plan accumulation?
- Can you handle volatile portfolios with ups and downs?
- Would you prefer conservative investment strategies?
- Do you require your funds to be liquid anytime soon?
- Can your money afford to be stashed away for a long time?
You would require a minimum of 5 years lock-in to offset charges that management firms charge.
2. Understand the Expense Ratio
The management’s advisory fee along with the basic operating expenses are known as your expense ratio. It means that you should be aware of the cost of owning your funds. You need funds that have the lowest expense ratios. Remember that a higher expense ratio means that for the money to start accruing into your pocket, it will take time. Over time, such seemingly measly percentages can end up as a decelerator to your wealth growth.
3. Avoid High Turnover Ratios
Know about the turnover rate of your portfolio. This is the proportion of the portfolio which is sold and bought every year. This has a lot to do with your taxes. If you have invested solely through tax-free instruments, then you shouldn’t be worried. Otherwise, taxes take a chunk out of your investments especially if you are the cream of the financial community.
4. Choose No-load Mutual Funds
Many companies charge a fee of about 5% of the assets. When you put tougher a portfolio, it comes down to simple calculations. In the long term, even a 5% charge on a large sum of money will result in you losing a huge chunk of earnings by the time you get to your retirement age.
5. Learn What Is the Appropriate Benchmark
Every fund has a different end-game, and hence a different approach to investing. So if you don’t know what to compare your portfolio against, you may just be barking up the wrong tree. To know if your portfolio manager is working well, research well against the appropriate benchmark. View historical data to understand how you are doing compared to others.
6. Work on Diversification of Assets
Warren Buffet has been known to say that if you know nothing about the market, make extremely diversified investments. If you cannot make decisions about a company’s intrinsic values, then you should spread your assets amongst several sectors, companies, and industries. That doesn’t mean you simply put your money in three different funds all concentrated in the financial sector. That isn’t diversification. Do not invest all funds in one sector because if the sector or industry takes a hit, you lose. Also, invest in different fund families.
7. Know the Benefits of Index Funds
Index funds are one of the perfect long-term investment choices. They are a combination of all that we have spoken for- phenomenally low expense ratios, low turnover rates, and ample diversification. Decade long investments are the kind that will give you good returns that compound over time.
8. Know About the Liquidity of Your Funds vs Your Age
Open-ended funds are eligible for total or partial redemption at the current share value. Makes sense for people who are older and need to worry about losing money over a price drop. Younger people have the luxury of making long-term investments that are more safeguarded against an immediate backlash in market fluctuations. As you grow older, your investment strategies have to become a bit more conservative rather than aggressive.
9. Understand Passive vs Active Asset Management
Understand if you want a fund that is actively managed or passively handled. It is an important consideration in how to find the right mutual funds. Actively handled mutual funds usually have portfolio managers that make many decisions about what securities and assets to take in in the fund. These managers do a prodigious amount of research on monies and consider sectors, business fundamentals, economic movements and macro-economic influences when making an investment decision. Active funds look to outdo a benchmark index, based on the kind of funds. Fees tend to be higher for such active funds. Expense ratios usually vary from 0.6% to 1.5%.
Funds that are passively managed are the previously discussed-index funds that seek to find and duplicate previous performances of certain benchmark indices. The fees are mostly lower than those of actively managed funds, and the expense ratios may be as low as 0.15%. Passive funds will not trade the assets often except if the composition of the benchmark index is altered. This is why these funds are more low cost. These funds could have multiple holdings, consequentially leading to well-diversified funds. As passively managed funds have no trade like active funds, they do not increase your taxable income.
10. Scheme Asset Size Matters
Classically, the fund size does not hamper its ability to reach its investment objectives. Having said that, a mutual fund buying guide should caution you that there are times when funds are too large. If the focus shifts from buying mid-cap stocks towards larger growth stocks, then performance can suffer.
It may seem like a daunting task to filter all this information and pick the right mutual fund. But a bit of research and due diligence on your part is half the battle won because you will certainly reap the benefits of a well-made decision.