This checklist will help you select the right mutual fund to invest in
Investors are often confused when it comes to investments in mutual funds as there are plenty of them. With over 40 AMCs and hundreds of schemes, plans and options on offer, one has a tough choice. When it comes to aligning your investments with your needs, a mix of both qualitative and quantitative factors comes into play.
Here we look at a framework of some important points to consider before investing in a fund.
Step 1: Find the Perfect Fund Match with a Personality Quiz
In order to identify your overall investment objectives, the first step is to define your short and long-term investment goals.
The next step is to understand your risk appetite, the risk appetite evaluation process takes into consideration both the tangible (eg - liabilities and income) and intangible factors (eg - degree of risk aversion) to determine the risk-taking ability of an investor.
Then, you need to align all the objectives with the risk appetite and pick funds that are the best fit for you.
Step 2: The Importance of a Risk-Adjusted Return
A 13% return with low volatility should be preferable compared to a 15% return with high volatility. One must understand that a handpicked fund must outperform the index fairly in the long run, else sticking to the index funds is a smarter and safer bet.
More importantly, it is important to look at the returns in risk-adjusted terms rather than absolute figures, that is where the Sharpe and Treynor ratio comes in. In other terms, a risk-adjusted return is a measure that puts returns into context based on the amount of risk involved in an investment.
For example - a 13% return with acceptable risk is better than a 15% return with high risk because the returns are not optimised with the increase in the level of risk.
Step 3: Understanding the Fund's AUM
In simple words, the AUM (Assets Under Management) means how many subscriptions the scheme has received. In the equity category, especially in small-cap funds, a large AUM can make it hard for the fund to enter and exit companies.
On the other hand, larger sizes of AUM are favourable in the case of liquid and short-term debt funds as it makes the fund less vulnerable to redemptions made by large investors.
Step 4: The Importance of a Long-Standing Fund Manager
You may wonder why the longevity of the fund management team matters. The answer is that it brings consistency in investment strategy and experienced fund managers who have sustained over a long period of time have seen and survived different market cycles.
Let’s understand it with an example - A fund manager who entered the market during a bull run will have outstanding performance in his/her career duration but that does not necessarily reflect his capability to manage a fund.
Whereas, a fund manager who has experienced 3-4 market cycles can make a better judgement based on experience. It is important to understand that the quality of a fund manager does not always lie in picking every money-making trend.
A good fund manager should also be able to identify the downward trends and take calls to manage risk at the right time.
Step 5: Don't Overlook Liquidity
It is one of the most overlooked factors when it comes to choosing the right fund for investment. Investors tend to be more focused on the risk and return part.
However, one must be aware of the ease with which the investment can be encashed at the time of need and the penalties associated with early withdrawal.
Step 6: Know the Fine Print before Investing
Fees a.k.a expense ratio of a fund reflect the fee charged by an AMC for the administration, management, promotion and distribution of a mutual fund. The taxes for mutual funds are different for different categories.
For example, if you sell equity funds before a period of 1 year they attract STCG tax at 15% while debt funds sold before 3 years will attract STCG tax as per your income bracket (30% being the peak rate).
Similarly, equity funds sold after a year will be taxed at a flat rate of 10% as per the LTCG category and for most of the debt funds, falling under the LTCG category i.e., if the funds are held by the investor for over 3 years, it can be taxed at 20% with indexation benefits.
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