It is always good when there are plenty of choices available before us. But the problem arises when we have to pick up one among them. When you choose one after some time the other will look better. Coming to a conclusion is difficult at times. There are numerous Mutual Funds are in the Market to choose from. You may search in Google to find out ‘Top 10 Mutual Funds’, ‘Best Mutual Funds in 2013’ etc and find some of the top performing Mutual Funds tabled by many websites and offline Magazines. You can choose the mutual funds that are placed in those lists but past performance of those funds may or may not happen in the future. So it is important that instead of choosing the funds in these lists, you must have your own Investment objective i.e. Expected Rate of Returns, Stop Loss, Risk Appetite, etc. Let’s discuss how to choose Mutual Funds.
You have to have an Investment Objective before you make any investment. It means that how you want your money to be invested, how much return you expect and how long you are going to stay invested, etc. In order to choose Mutual Funds you have to study and understand the following points:
Open Ended or Closed Ended:
Mutual Funds give you two options are Open Ended Schemes and Closed Ended Schemes. An Open ended scheme is that allows you to buy and sell the units of the scheme at any time during the business hours. There is no restriction on the number of transactions at any time.
A Closed Ended Scheme is that allows you to buy units only at the New Fund Offer (NFO) i.e. when the units are offered for investment. These schemes have fixed maturity period, only after that you can redeem their units. But, they are listed in the stock exchanges after the initial offer where you can buy and sell the units.
If you want to enter and exit any time in a scheme you have to choose Open Ended Schemes and if you want the scheme to allow the scheme to take its time and generate the returns as per its objective you can choose Closed Ended Schemes.
Equity or Debt:
A Mutual Fund can be either Equity oriented or Debt oriented. An Equity oriented fund invests most of its fund in shares of the companies and Debt oriented funds invest in fixed income instruments like Bonds, Treasury bills, etc.
If you want your money grow faster and ready to face downs you can invest in Equity oriented funds or if you want protection for your investment with little bit of return you can go for Debt Funds. (Read: How to Choose Debt Instruments?) (Also Read: What is Equity?)
Growth/Dividend Payout/Dividend Reinvestment:
You can choose how your investment money invested in any Mutual Fund. Returns of Mutual Funds can be accumulated in Growth option. If you want regular income you can choose Dividend Payout or if you want the dividends earned by the scheme to be reinvested, you can choose Dividend Reinvestment option. (Read: Growth, Dividend Payout, Dividend Reinvestment: What is What?)
Every Mutual Fund scheme has its own Benchmark by which it tracks the returns. An index is the benchmark for a fund. It invests in the companies indexed in that and tries to beat the Benchmark. The main objective of Mutual Funds is to beat the Bench Mark otherwise you can simple invest in Index Funds where the expenses are less. (Read: Investment in Index Funds: An Introduction)
Before investing in any Mutual Fund, it is necessary to have a look at its past performance. The returns of the fund should be compared to the funds in the same category. Mutual Funds issue fact sheets then and there you can find the performance of the fund by analyzing this sheet. Though past performance may or may not indicate or guarantee future returns, it is essential to know if the fund has the capabilities to generate better returns.
Lump sum or SIP:
Investments in Mutual Funds can be made by Lump sum or through Systematic Investment Plan (SIP). When you have lump sum money you can invest in Liquid funds and can use Systematic Transfer Plan (STP) to transfer the funds in small amounts from Liquid funds to other funds on a regular basis. SIP method is the most effective way to accumulate money in the long run. You can invest small amounts at regular intervals and average the price to get good returns.
Expected Rate of Returns & Risk Appetite:
You must decide on how much return you expect from your investments. Your expected rate of returns is based on the number of years you’re going to get invested. You may need money after 5, 10, 15 years or you may want it for your after retirement life. So you have to decide on number of years you need to get invested. Investment made in Equities give better returns in the long run and if you want to fund your short-term needs you have to choose Debt funds.
If you can’t take too much of risk your exposure to equity should be lesser than Debt and if you’re ready to wait and never mind the market ups and downs you can invest in equities.
Large Cap/Mid Cap/Small Cap/Sectors/Diversified:
The objective of all Mutual Funds is to generate returns by investing the money in various ways. Mutual Funds invest in different segments like Large Cap, Mid Cap and Small Cap Companies. They invest in different sectors and diversity the investments in order to reduce the risk. Not all the Mutual Funds follow the same method. So you have to decide where you want your money to be invested. You can decide it before investment as you can find the objectives of Mutual Funds in their offer documents. The method of investment will be well defined in the offer documents. Though returns are slow large cap mutual funds give better protection during the downfall. Mid cap and small cap funds can deliver higher returns with higher risk tag. So your affordability of risk determines the segment in which your money to be invested.
There are other factors which influence the returns of Mutual Funds are Expense Ratio, Mutual Fund Manager, etc. The Expense ratio is the percentage of your invested money that goes for running the Mutual Funds, for example Salary for Staff, Administration expenses, Sales and Promotion expenses, etc. If the expenses are higher the expenses you can expect only lesser returns. If the returns justify the expenses, higher expenses are no matter.
The qualification and expertise of every Fund Manager is an important aspect of every Mutual Fund. A well qualified and experienced Fund Manager is likely to manage your money effectively to generate good returns. The expertise of the Fund Manager can be examined by other funds he/she manages, the returns of those funds, expenses ratio, etc. (Read: Benefit of 'Direct Plan' in Mutual Funds)
Your Investment goal should be clear that how much can you invest, how long can you invest, how much you need and for what purpose. Determination of the purpose of investment is very important as it is the one which decides everything said above.