How to select the right mutual funds?

It is a fact that mutual funds are the best option for long term investment. But how to select the best mutual funds is a headache and confusing if you rely only on Google.

Two reasons why you should not search google for selecting right mutual funds.

Don’t trust mutual fund rating

There are the plethora of websites where you can find mutual funds ranking based on the stars i.e. 3 stars, 4 stars, 5 stars etc.  Mutual Fund Ranking is predominantly decided based on past performance of 1 Year, 3 Year or 5 Year. I can also have my own version of mutual funds ranking based on the past performance of say 1 year, 3 years, 5 years. A star performer fund this year might be worst performing fund next year. It is advisable to review the investment portfolio every 6 months. You will not know but, there are even some inflated ratings of funds as those are paid ratings by certain websites.

Link your investment decision with your goals.

You will find some mutual fund scripts are outperforming in past 10 years or since inception. Here you need to ask yourself a question whether your goal for which you invest is in line with the performance of the fund? A star performer fund this year might be worst performing fund next year. You should check the economy movement for next one or two years. I know it’s very cumbersome exercise but at least you should have a broad idea of where the economy is heading to.

Steps for selecting right mutual funds

  • Identify your financial goals and horizon
  • This is the foremost requirement before we start selecting funds. We need to understand our financial goals and objectives. We need to know WHY are we investing? These objectives could be long term, short term or event based like child’s higher study or marriage. Once we finalize these goals, we can determine the risk factor attached to the funds. In short, how much negative returns I can bear? This will help you to decide the macro level selection of funds. Based on the answer, you can go for equity, debt or liquid funds.
  • Type of funds
  • Based on your horizon and risk appetite you can choose the type of funds which is suitable to your investment profile. If your goal is for the long term, you can go for equity funds which are best in class for the long term. These type of funds are holding a high portion of investment into common stocks and has good potential for high returns in the long term.
  • Economic outlook
  • If you are going for short term horizon, debt and liquid funds are for you. The market tends to be more volatile in short term as compared to long term. Let me admit, no one can get the exact idea of where the market will go. No investment guru can predict it right. It is all judgment and assessment. Do some prediction and economic research by yourself and find out where you see market will go.
  • Mutual fund ranking
  • Check the ratings of mutual funds on different legitimate sites. You will find a different rating for the same fund on a different website.  It is confusing and everyone has its own way of ranking mutual funds. I would suggest you take a ranking of two or three best funds which you trust the most. I personally trust mutual fund ranking of CRISIL because their rankings are unbiased and done by experts.
  • Fees and Charges
  • Mutual fund houses are making money by charging fees to the investors. It is important to understand the different types of charges levied on you during the whole investment process. This includes entry and exit loads(fees) which are common for any fund. I give more weight-age on exit load as compare to entry load. You must know the exit load as you might need your money before you reach your goal. At this time it is very important to understand the charges deducted by fund house on your invested money. Don’t go for a fund whit higher exit load.
  • Expense Ratio
  • Check expense ratio of the scheme as it is a part of your returns which goes to fund house to compensate their expenses. An expense ratio is between 1% to 1.5% which is considered to be normal. Anything above this is not advisable. You should avoid schemes which expense ratio above this tolerance level.
  • Fund Manager
  • Fund house have different fund managers for the different scheme. There are fund managers who manage more than one scheme as well. These are the people who take investment decision of your money. So it is important to know in whose hand your money is? and is it safe or not? Going with the best fund manager will give you confidence and high returns.

With the help of above steps, you will be able to filter out unnecessary funds and find best suitable funds for your need. Though the mutual fund is the safest way to invest, it is not always true. Mutual fund investments are subject to market risk. No one can time the market but it is advisable to study the trend before investing.

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