How to Compare Mutual Funds

When analysing mutual fund performance, compare it to benchmarks, check the expense ratio, study fund history, assess portfolio strength, examine the portfolio turnover ratio, compare maturity periods, and evaluate risk-adjusted returns to ensure a comprehensive evaluation.
How to Compare Mutual Funds
4 mins read
21-June-2024

When it comes to investing in mutual funds, investors are mostly spoilt for choice as they are over 2000 mutual funds in the market. However, comparing mutual funds can be quite challenging, especially if you're new to investing. You need to take into account a range of factors, which can make the process daunting.

While having options is unquestionably a positive thing, having too many possibilities might make choosing a fund challenging. Choosing the right mutual fund is essential for reaching long-term objectives, especially since investing requires a long-term commitment utilising your hard-earned money. This is where having a clear understanding of how to compare mutual funds' performance, and other attributes can help choose investment strategies that are in line with your investment aims.

Why should you compare mutual funds?

When considering mutual fund options, you will find many funds with enticing benefits and low initial investments. However, at first glance, funds within the same category may seem alike, making decision-making challenging. Investing requires long-term commitment, so it is crucial to understand what you're getting into. While many investors focus solely on fund returns, it is essential to consider other factors such as consistency of returns, fund house reputation, and risk-adjusted returns.

Fund returns indicate the difference between the Net Asset Value at the start and end of a specific period. Annualised returns reflect value changes over time, but evaluating consistency, fund quality, and risk-adjusted returns is equally important. Comparing mutual funds based on these aspects and using financial ratios can guide you in making informed decisions about the right fund for your investment goals.

How to compare mutual funds?

When investing in mutual funds, it is essential to compare your options thoroughly to make informed decisions. By evaluating factors like performance, fees, risk levels, and investment objectives, expense ratios, etc. investors can determine which mutual fund aligns best with their financial goals and risk tolerance. Let us explore in detail:

1. Expense Ratio

The expense ratio is the fee that fund houses charge for managing your investment portfolio. It comprises expenses such as management fees, marketing expenses, administrative expenses and so on. The expense ratio is calculated as a percentage of your investment in the fund. Generally, the lower the expense ratio, the better.

2. Investment Objective

Before investing in mutual funds, you need to determine your investment objective. Once you have identified your goals, choose a mutual fund that aligns with your investment objectives. For instance, for long-term investment goals, equity funds are preferable, while debt funds are suitable for short-term investments.

3. Mutual fund performance comparison

When comparing mutual funds, you must take the performance of the fund into account. The performance of a fund can be traced back to its past returns. However, past returns do not guarantee future returns, so one must exercise caution when using them to make investment decisions.

4. Risk Profile

The risk profile of a mutual fund is determined by the percentage of equity and debt instruments it holds. Funds with a higher percentage of equity are riskier but offer higher returns. On the other hand, debt funds are less risky but provide lower returns. Depending on your risk appetite, select a mutual fund that matches your risk profile.

5. Asset Under Management (AUM)

A fund's AUM reflects its popularity and the level of investor confidence. While larger AUM may indicate a more stable fund, it could also lead to slower growth and reduced flexibility.

6. Exit Load

When you invest in mutual funds, you need to keep in mind the exit load, which is a fee charged if you withdraw your investment before the stipulated time. Exit loads vary from fund to fund and can impact your returns.

Frequently asked questions

Why do we need to compare mutual funds?

Selecting the appropriate mutual fund is crucial for making long-term investments. While mutual funds are divided into categories such as equity, debt, and hybrid, there are also several subcategories that offer investors a wider range of options. Therefore, comparing mutual funds is a very critical step in choosing the appropriate investment.

How can comparing mutual funds help me manage risk?

To manage and reduce investment risk, a useful approach is to identify mutual funds that suit your risk tolerance by comparing their risk levels.

What are some common mistakes to avoid when comparing mutual funds?

Mutual fund should not be selected based solely on past returns. It is important to assess risks, costs, and alignment with your investment objectives to avoid mistakes commonly made in fund selection.

Why is information about a fund manager important?

Information about a fund manager is crucial as their expertise and decision-making significantly impact the performance of a mutual fund. Understanding their track record, investment philosophy, and experience helps investors make informed decisions.

What is VRO rating in mutual fund comparison?

The VRO (Value Research Online) rating employs a grading system, assigning mutual fund schemes a rating ranging from 1 to 5 stars. A 5-star rating indicates that a fund is among the top choices for investment. Websites specializing in mutual fund comparison commonly present a VRO rating as a concise summary of a scheme's overall performance.

Which is the best mutual fund scheme?

Determining the best mutual fund scheme depends on individual financial goals, risk tolerance, and investment horizon. There is no one-size-fits-all answer, and investors should choose funds aligned with their specific objectives, whether it's growth, income, or a combination of both.

What is the best indicator of a successful mutual fund?

The consistency of returns over time is often considered the most reliable indicator of a successful mutual fund. Evaluating a fund's long-term performance against its benchmark and peers helps gauge its ability to deliver consistent returns across various market conditions.

What to check before investing in mutual funds?

Before investing, it is crucial to assess several factors such as the fund's investment objective, historical performance, expense ratio, manager expertise, and risk level. Additionally, understanding the fund's strategy, portfolio composition, and any associated fees is essential to make an informed investment decision.

What are three disadvantages of investing in mutual funds?

While mutual funds offer diversification, professional management, and liquidity, they also come with drawbacks. These include management fees, potential for underperformance, and lack of control over individual investments. Additionally, certain funds may have high turnover rates, leading to increased tax liabilities for investors.

What are the indicators of a mutual fund performance?

Mutual fund performance is judged by returns over various periods, expense ratios, volatility (standard deviation), Sharpe ratio (risk-adjusted return), and fund manager tenure. Consistency in performance, benchmark comparison, and sector performance are also crucial indicators.

Why is past performance not a benchmark for a mutual fund comparison?

Past performance doesn't guarantee future returns due to market volatility, changing economic conditions, and fund management changes. It reflects historical market conditions and may not be sustainable. Factors like expense ratios and investment strategy are more reliable indicators of future performance.

How to read a mutual fund?

Examine the fund's objectives, investment strategy, and risk level in its prospectus. Check performance over different time frames, expense ratios, and fees. Understand holdings and allocation to stocks, bonds, or other assets. Assess the fund manager's experience and strategy alignment with your financial goals. Always compare with benchmark indices for context.

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Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.