Mutual funds are like treasure chests for investors, offering a diverse range of investment opportunities managed by professionals. But with thousands of options, finding the right one feels like searching for a needle in a haystack.
Fear not, we are here to simplify the process and help you find the perfect mutual fund that fits your financial dreams. From understanding key features to the performance metrics, we will guide you through every step. Get ready to unlock the secrets of selecting the ideal mutual fund to make your money work smarter and grow your wealth effortlessly. Let us explore how to choose mutual funds, factors affecting mutual fund selection and many more in detail.
How to choose mutual funds for investment in 2024?
Selecting a mutual fund is a 2-step process – selection of the mutual fund category and selection of a scheme in that category. Here are the factors which an investor should consider while selecting a mutual fund scheme:
Factors to consider before selecting mutual fund category
Investment objective
Firstly, it is imperative to define your investment objectives clearly. Whether your aim is to purchase a property, finance your child's education, prepare for retirement, or indulge in a dream vacation, discerning your financial goals provides the compass for selecting the most suitable mutual fund. Various categories cater to diverse goals; for instance, equity funds prove advantageous for long-term aspirations exceeding five years, owing to their potential for higher returns. Conversely, debt funds are conducive to shorter horizons ranging from one day to five years, offering comparatively lower risk. Hybrid or balanced funds amalgamate equity and debt components, presenting a middle ground with moderate risk.
Time horizon
Assessing the timeframe for your investment tenure is crucial. Different fund categories exhibit varying performance dynamics over distinct time frames. Liquid funds are apt for addressing very short-term financial needs spanning one day to three months, while ultra short-duration funds cater to periods of three months to one year. Short-duration funds accommodate investment horizons ranging from one to three years, whereas hybrid or balanced funds are conducive to durations spanning three to five years. Equity funds, known for their potential to yield significant returns, are recommended for investment periods exceeding five years.
Risk tolerance
Understanding and evaluating your risk tolerance is paramount. The Securities and Exchange Board of India (SEBI) categorises funds into five levels based on risk, ranging from low to high. Aligning your risk tolerance with the appropriate fund category ensures that your investment strategy remains congruent with your comfort level. By considering these essential factors with care and diligence, investors can navigate the landscape of mutual fund categories with clarity and confidence, laying a robust foundation for their investment journey.
Factors to evaluate before choosing mutual funds
Goals
The first step is to identify your financial goals and the time horizon for achieving them. Different mutual funds have different objectives, such as capital appreciation, income generation, tax saving, etc. You should choose a mutual fund that matches your goal and risk profile. For example, if you want to save for your retirement, you can opt for a balanced or hybrid fund that invests in both equity and debt instruments. If you want to save tax, you can invest in an equity-linked savings scheme (ELSS) that offers tax benefits under Section 80C of the Income Tax Act.
Risk
The second factor is to assess your risk appetite and tolerance. Mutual funds are subject to market fluctuations and can have varying degrees of risk, depending on the type and composition of the underlying assets. Generally, equity funds are riskier than debt funds, while small-cap funds are more risky than large-cap funds. You should choose a mutual fund that suits your risk profile and does not expose you to undue stress. For example, if you are a conservative investor, you can invest in a liquid or ultra-short-term fund that offers low risk returns. If you are an aggressive investor, you can invest in a sectoral or thematic fund that focuses on a specific industry or theme and offers high returns with high risk.
Liquidity
The third factor is to consider the liquidity of the mutual fund. Liquidity refers to the ease and speed with which you can buy or sell units of a mutual fund. Different mutual funds have different liquidity features, such as lock-in period, exit load, redemption limit, etc. You should choose a mutual fund that offers you the flexibility to withdraw your money when you need it. For example, if you want to invest for a short term, you can choose an open-ended fund that allows you to redeem your units at any time without any penalty. If you want to invest for a long term, you can choose a close-ended fund that has a fixed maturity period and offers a higher return potential. It is crucial to note that access to closed-ended schemes is limited, allowing investments only during the New Fund Offer (NFO) period.
Investment strategy
The fourth factor is to understand the investment strategy of the mutual fund. Investment strategy refers to the approach and philosophy adopted by the fund manager to select and manage the portfolio of the mutual fund. Different mutual funds have different investment strategies, such as growth, dividend, index, etc. You should choose a mutual fund that aligns with your investment style and preference.
Fund performance
The fifth factor is to evaluate the performance of the mutual fund. Performance refers to the returns and risks generated by the mutual fund over a period. You should compare the performance of the mutual fund with its benchmark and peer group, and consider the consistency and stability of the returns. You should choose a mutual fund that has delivered superior and consistent returns over the long term, and has outperformed its benchmark and category average. However, you should also remember that past performance is not a guarantee of future results, and you should review the performance of the mutual fund periodically.
Expense ratio
The sixth factor is to check the expense ratio of the mutual fund. Expense ratio is the annual fee charged by the mutual fund for managing your money. It includes various costs, such as management fee, distribution fee, etc. Expense ratio reduces the net return of the mutual fund, and hence, you should choose a mutual fund that has a low expense ratio. However, you should also consider the quality and value of the services provided by the mutual fund, and not compromise on the performance and suitability of the mutual fund for a lower fee.
Exit load
The seventh factor is to look at the exit load of the mutual fund. Exit load is the fee charged by the mutual fund when you sell units of the mutual fund. Exit load reduce the net return of the mutual fund, and hence, you should choose a mutual fund that has no or minimal exit load. However, you should also consider the liquidity and lock-in period of the mutual fund, and not invest in a mutual fund that has a high exit load and a long lock-in period.
Taxes
The eighth factor is to consider the tax implications of the mutual fund. Taxes are levied on the income and capital gains earned from the mutual fund, depending on the type and duration of the mutual fund. Generally, equity funds are taxed at 15% for short-term capital gains (less than one year) and 10% for long-term capital gains (more than one year), with a threshold of Rs. 1 lakh. Debt funds are taxed at the marginal tax rate for short-term capital gains and 20% with indexation for long-term capital gains. You should choose a mutual fund that offers you the best post-tax return, and take advantage of the tax benefits available for certain mutual funds, such as ELSS.
Direct plans
The ninth factor is to opt for direct plans of the mutual fund. Direct plans are the plans that allow you to invest in the mutual fund directly without any intermediary, such as a broker, agent, or distributor. Direct plans have a lower expense ratio than regular plans, as they do not include any commission or distribution fee. Direct plans offer you a higher return potential, as the savings in the expense ratio are added to your returns. You can invest in direct plans through the online platforms of the mutual fund houses or through third-party portals.
