How to Choose Mutual Funds in India

Mutual fund selection is based on several parameters. These include return expectation, risk tolerance, and investment horizon. There are different parameters to consider for fund selection including expense ratio, past performance, fund manager experience, and assets under management.

Once you, as an investor, do your research, you will have a clear idea as to where you want to invest. And what type of category or funds. 

How to choose mutual funds is a common question. Here is a guide to mutual fund investment, you may consider while selecting mutual funds for investments.

Goals

This is the basic. When you invest in a mutual fund, keep your target in mind. That is, what is the purpose of investment. How long are you planning your investment and with what return expectations?

In the absence of a clear goal, you may want to exit your investment for small fluctuations.

A goal can be short terms like purchasing utility goods, a down payment for a house or an international holiday. It can be for the long term as well, like retirement or college education for children.

Depending upon why you are investing, you will be how to choose best mutual funds to select the mutual fund type. It can be a debt mutual fund, equity mutual fund, or hybrid mutual fund.

For example, for some investors, the main investment objective is to gain capital appreciation on their investments. For others, it may be tax saving. 

Risk

A significant criteria for selection of mutual funds is analysing the associated risk.

Risk comes from not knowing what you are getting into. Before choosing a mutual fund, the investor should analyze the risk associated with the investment. And he/she has to check if the risk is comfortable. 

Equity mutual fund investments are subject to market fluctuations. Therefore, an equity-oriented portfolio could witness volatility as well in the short term. But note that, the returns can be substantially higher than other types of funds. These types of funds might be suitable for long-term aggressive investors. 

Debt mutual funds are comparatively more stable. But the returns could be lower than equity funds.  These might be suitable for conservative investors. You can follow the table below to understand the category you fall into based on the time horizon and your risk profile, to select the appropriate mutual fund for yourself.

Liquidity

Another factor that one should consider to look into while feeling how to select mutual funds for SIP, is liquidity.

Investors should know when he/she may require the investment. That is, if the need is in the near future, it’s not for equity mutual funds. This is because it may not provide the expected return.

If you can stay with the investment for one year or more, then equity mutual funds can generate the expected returns. This is also important because compounding works best when money is left untouched for long periods of time. So, if you want to raise money for a short period, go for liquid funds. 

Investment Strategy

While identifying how to select best mutual fund, most investors ignore the aspect of investing strategy. But it holds a crucial place in the success of your investment portfolio.

An investment strategy is also referred to as the investment approach. It is a strategy that the fund houses adopt to make all the investment decisions. If the investment strategy of the fund house is not in line with your investment philosophy then a conflict of interest will arise. And ultimately leading to you exiting the investments at undesirable prices. 

Fund Performance

Fund performance matters. It should be considered for a reasonable time frame. This is to ensure that the investments have gone through multiple market cycles. This would enable consistent returns over a period.

In case the fund has not been able to beat its benchmark over three, five, seven or ten years, it is reasonable to believe that the fund might not be a good investment.

While evaluating a fund’s performance, it is important to check the performance details of the fund manager or the fund management team. A strong, stable, experienced Fund management team with reasonable tenure and a proven track record would prove beneficial for investors.  

Expense Ratio

The expense ratio is the commission or the fee charged by the investors for the proper management of their investments. It is basically the fund manager’s fee that is levied upon all investors for ensuring profits across the investments.

As an investor, you must target mutual funds that have a lower expense ratio. This is because, the percentage may seem quite small but when calculated across your total investment portfolio, it will have a larger impact.

The expense ratio is a derivative of Assets Under Management and it is believed that the higher the AUM, the lower the expense ratio. 

Entry And Exit Load

Entry load refers to the fee charged by fund houses from investors.

Exit load refers to the fee charged at the time of exiting a mutual fund scheme. This is chargeable only if investors exit within a short period. This is to discourage quick exit and immediate outflow of cash from fund houses. 

The entry load has however been removed by most fund houses.

As an investor, you must look out for mutual fund schemes that have zero or minimal entry and exit load.

Taxes   

When you as an investor make money (returns) from your investment, it is taxable as per Income Tax Act.

When equity fund units are redeemed, the returns are taxable as per the period of holding.

For equity funds, Long Term Capital Gains (holding period of 12 months and above) are taxed at 10% over and above the exemption limit of Rs 1 Lakh.

Short Term Capital Gains (holding period of less than 12 months) are taxed at 15%.

For Debt funds, indexation benefit is available for capital gains realized.

(For these funds, a holding period of 36 months or more is considered as long term. Any holding period which is less than 36 months is treated as short term and the gains are taxable). 

Direct Plans 

There are two types of plans available for a mutual fund scheme: direct and regular.

Direct and regular Mutual Funds are different versions of the same plan.

In the case of direct, investors can directly buy required NAV units from a concerned fund house. In the case of regular, the units have to be purchased through a commissioner or broker. 

A key difference between the two is that returns are slightly higher in a direct Mutual Fund as no commission expenses are incurred. This commission varies between 1-1.25%, depending upon the asset management company and brokerage firm.

In the case of regular Mutual Funds, the concerned Asset Management Company (AMC) pays a commission to the brokerage firm for increasing their clientele. This reduces the principal amount of investment, thereby reducing total returns generated. 

Earlier when mutual funds were just introduced in India, going the regular route made sense due to a lack of awareness. However, now there are many platforms that offer you the necessary resources to make investment decisions. So you need not always be dependent on agents for advice. Also, you may consider using this guide to find answers to how to select mutual funds as well.

Happy Investing!