5 Steps to Select Mutual Funds

5 Steps to Select Mutual Funds

Heard about mutual funds? Plan to start investing in them? The first step most of us would take is to do a search on the internet… the result? Too many options! This would often lead to a sense of being overwhelmed. However, there is a way to simplify your selection and make your journey to investing in mutual funds easy and convenient.

To invest in mutual funds, take these 5 steps to shortlist your mutual funds:

Fund House Pedigree

Before you decide on which mutual fund scheme you want to invest, it’s important to first check out the reputation of the fund houses that offer schemes. To assess a fund house’s reputation, you should consider one with a good parentage and trusted brand name.

Track record of scheme

Now that you have shortlisted a suitable fund house, the next step is to decide what schemes to invest in. Every fund house offers numerous schemes. Short-list your selection to schemes that have performed well in the past. To assess this, check the returns offered by the fund vis-à-vis its benchmark index and other funds in its category over the long term. But do keep in mind that good performance in the past will not necessarily guarantee good performance in future. Unfortunately, most investors rely solely on past performance while making their selection of funds; this is not advisable.

One should also consider the current market situation and assess its impact on the future performance of their funds of choice. For instance, since the markets could remain volatile this year, we are currently recommending defensive equity investing in asset allocation funds or funds that benefit out of volatility.

These funds invest in equities when markets are cheap and book profits when markets are rising, thus limiting risk and aiming to provide long term returns. Investor should consider investing in such funds with an aim to benefit out of volatility.

The investment objective

Each scheme has an investment objective. While selecting funds, it is important to align the investment objectives of the fund to one’s financial goals. For instance, Investors comfortable with market volatility and have a long-term investment horizon may invest a portion of their funds in small and midcap funds; remember, equity as such is a more volatile asset class and mid and small caps are even more volatile. Your long term investment horizon will help you ride this volatility to make gains. If you have a 3-year horizon, you are better off investing in large cap funds since these funds offer more stability.

 The risk profile

While equity funds carry the risk of fall in market prices of stocks due to changes in the economy, business, etc., debt funds carry the risk of changes in interest rates, possibility of default by borrower, etc. To understand the risk carried by a particular fund, see the riskometer of the fund (it is provided in the Scheme Information Document and on the Key Information Memorandum and application forms). It’s important to match your risk profile with that of the fund you want to invest in.

The payout options

Each fund offers three options to receive your investment income:

1. Dividend payout;

2. Dividend reinvestment;

3. Growth.

If you are looking to build wealth over the long term, the growth option should be preferred. However,  if you need regular income flows, you may select the dividend-payout option.

With these 5 steps, your journey to mutual fund investing will be a pleasant one.

Happy Investing