Why Choose Mutual Funds?
What's strategy got to do with selecting a mutual fund? Shouldn't you just go and invest in the best performing fund? The answer is no. Mutual fund investing requires as much strategic input as any other investment option. But the advantage is that the strategy here is a natural extension of your asset allocation plan (use our Asset Allocator to understand what your optimum asset allocation plan should be, based on your personal risk profile). moneycontrol recommends the following process:
Identify funds whose investment objectives match your asset allocation needs
Just as you would buy a computer that fits your needs and budget, you should choose a mutual fund that meets your risk tolerance (need) and your risk capacity (budget) levels (i.e. has similar investment objectives as your own). Typical investment objectives of mutual funds include fixed income or equity, general equity or sector-focused, high risk or low risk, blue-chips or turnarounds, long-term or short-term liquidity focus. You can use moneycontrol’s Find-A-Fund query module to find funds whose investment objectives match yours.
Evaluate past performance, look for consistency
Although past performance is no guarantee for the future, it is a useful way of assessing how well or badly a fund has performed in comparison to its stated objectives and peer group. A good way to do this would be to identify the five best performing funds (within your selected investment objectives) over various periods, say 3 months, 6 months, one year, two years and three years. Shortlist funds that appear in the top 5 in each of these time horizons as they would have thus demonstrated their ability to be not only good but also, consistent performers. You can engage in such research through moneycontrol's Find-A-Fund query module.
Diversify
Don't just zero in on one mutual fund (to avoid the risk of being overly dependent on any one fund). Pick two, preferably three mutual funds that would match your investment objective in each asset allocation category and spread your investment. We recommend a 60:40 split if you have shortlisted 2 funds and a 50:30:20 split if you have shortlisted 3 funds for investment.
Consider Fund Costs
The cost of investing through a mutual fund is not insignificant and deserves due consideration, especially when it comes to fixed income funds. Management fees, annual expenses of the fund and sales loads can take away a significant portion of your returns. As a general rule, 1% towards management fees and 0.6% towards other annual expenses should be acceptable. Carefully examine load the fee a fund charges for getting in and out of the fund.
Invest, monitor and review
Having made an investment in a mutual fund, you should monitor it to see whether its management and performance is in line with stated objectives and also whether its performance exceeds or lags your expectations. Unlike individual stocks and bonds, mutual fund reviews are required less frequently, once in a quarter should be sufficient.
A review of the fund’s performance should be carried out with the objective of holding or selling your investment in the mutual fund. You might need to sell your investment in a mutual fund if any of the events below apply –
You change your investment plan.
For example, as you grow older you might adopt a more conservative investment approach, pruning some of your riskier (equity-oriented) funds.
A fund changes its strategy.
A fund that alters its investment objective or approach might no longer fit your strategy.
The fund's poor results persist.
If a fund regularly trails other funds that invest in similar securities, consider replacing it. The poor performance is more often than not a reflection on the relative expertise of the asset management company.
By now you would have realized that investing in mutual funds is not just a decision but is more a process. moneycontrol's Mutual Fund Investing Checklist can help make this process easier and more efficient.
Source/Credit: Moneycontrol.com