Skip to main content

How to choose a mutual fund?

Image
By
Mutual funds are meant to simplify the tasking of investing, but choosing the right one can itself intimidate many. Here's a primer to help you

With so many categories of mutual funds, fund houses, and schemes available, choosing a mutual fund is not an easy task for many investors. The best way to begin is to decide on a method to narrow down on the right fund for you. Rarely do investors who do something else for a living employ a systematic checklist to evaluate a fund they are considering buying. Here is our blueprint for a structured approach to fund selection. There are five areas that you must evaluate to decide whether a particular fund is a good investment.

Performance: Performance comparisons must be used only to compare the same type of fund. They are meaningless otherwise. Only when used within the same category of funds do performance numbers tell you anything at all. By the time you reach the stage when you are comparing performance numbers of different funds, you should already have a good idea of how much you will invest in that category.

Risk: Almost all investing is risky, at least those investments that get you any meaningful returns. In general it is said that the riskier a fund, the more its potential for earning high returns. However, this is a simplified view that implies that a given amount of risk always gets you the same returns. This is simply not true because not all funds are equally well-run.

The true measure of risk is whether a fund is able to give you the kind of returns that justify the risk it is taking on. Evidently, this is not as easy to measure as returns. There are a wide variety of statistical techniques that can be used to measure this. We distil a combination of performance and risk measurement into the Value Research Fund Rating. When we say that a fund has a five- or four-star rating, it means that the fund, compared to similar funds, performed better, given its risk level.

Portfolio: Unlike performance and risk, portfolio is one of the 'internals' of a fund. It is internal in the sense that the result of good, bad or ugly portfolios is already reflected in the first two measures and it's perfectly okay for you to choose funds on the basis of those two measures alone without actually bothering about what they own. Our basic analysis of portfolios measures whether a fund (we are talking about equity funds here) holds mostly large, medium or small companies. It also looks at whether a fund prefers companies that may be overpriced but which are growing fast or whether it prefers low-priced stocks belonging to companies that are growing at a more gentle pace. For fixed income funds, an analogous analysis tells one whether a fund prefers volatile but potentially high-return long-duration securities or stable and low-return short-duration securities. Also, one can analyse whether a fund prefers safer (lower returns) securities or riskier (higher returns) securities.

Management: Fund management is a fairly creative and personality-oriented activity. This may not be true of some types of funds like shorter-term fixed-income funds and of course index funds, but equity investment is more of an art than a science. When you are buying a fund because you like its track record (and unless you can foresee the future, that's the only way to buy a fund), what you are actually buying is a fund manager's (or sometimes a fund management team's) track record. What you need to make sure is that the fund manager who was responsible for the part of the fund's track record that you are buying into is still there. A high-performance equity fund with a new manager is a like a new fund.

Cost: While the above are the most important points on which to evaluate a fund, there is one more factor that is becoming increasingly significant, and that is cost. Funds are not run for free, nor are they run at an identical cost. While the difference in different funds' cost is not large, these can compound to significant variations, especially for fixed income funds where the performance differential between funds is quite small to begin with. Even for equity funds, it may not be worth buying a higher cost fund that appears to be only slightly better than a lower cost one. Remember, there is no reason for one AMC to have much higher costs than others, apart from the fact that it wants to have a higher margin, or that it wants to spend more on things like marketing, which are of no relevance to you. If an AMC wants higher returns from its business, then it must justify it by giving you higher returns on your investments.



Hope it helps you to start invest in mutual funds!!

Comments

Post a Comment

Popular posts from this blog

Commissions

By
Commissions: Commissions have become much smaller in the past two decades.Twenty years ago, there were still brokers who charged one-way commissions of between half a percent and one percent of trade value. Buying a thousand shares of GE at $20 a share, with a total value of $20,000, would have set you back $100 to $200 on the way in—and again on the way out. Fortunately for traders, commission rates have plummeted. The extortionate rates haven’t completely disappeared. While preparing this book for publication, I received an e-mail from a client in Greece with a small ac- count whose broker—a major European bank—charged him a $40 minimum on any trade. I told him of my broker whose minimum for a hundred shares is only $1. Without proper care, even seemingly small numbers can raise a tall barrier to success. Look at a fairly active trader with a $20,000 account, doing one roundtrip trade per day, four days a week. Paying $10 one way, by the end of the week he’ll spend $80 in commi...
18 comments
Read more
By
Building Your Go to Market Strategy When you introduce a product or service to a new market, there’s always going to be some risk. Over 30,000 new products are introduced every year, but 95% of new products fail. You don’t want to spend time and resources on a go to market plan that’s going to fall flat. A comprehensive go to market strategy acts as a roadmap, helping you research your market, position your brand, and unveil your new product or service. But before we look at how to build a go to market strategy framework, just what is “go to market” and how do you build a strategy around it? What Is a Go to Market Strategy? So, what does “go to market” mean? A go to market strategy (sometimes called a GTM strategy) is a plan of action that lays out how your company will reach customers in a new target market and gain a competitive advantage over other players in that market. It can also refer to how you’ll reach customers in an existing market with a new produ...
1 comment
Read more

SIPs - A habit to inculcate

By
The one conscious habit that everyone needs to adopt is the habit of SIPs. Saving something every month and investing it systematically in mutual funds is a habit that most of us should inculcate. It's not that hard and the long-term benefits are fabulous. Cultivating the SIP habit frees you from having to decide when and how much to invest. SIPs are in this sense the best way to invest in equity funds. Systematic investments average out the cost of your unit purchases, they don't put you at the risk of catching a market peak, and they earn you the benefit of compounding. And probably the most important benefit, from a non-technical perspective, is that SIPs force you to save and invest that definite amount periodically. Money saved is money earned, we know that. And in the case of SIPs, money invested is money that works to earn more money for you. Now, isn't that a habit you could get used to?
13 comments
Read more