For those who aren’t aware, a mutual fund is an investment vehicle that pools financial resources from retail investors and invests the accumulated sum across money market instruments and asset classes to achieve a common investment objective which is wealth creation in most scenarios. Since the mutual fund universe is vast and comprises a wide range of schemes, sometimes first time investors find this a bit overwhelming.
Let us take a look at a few things to keep in mind while choosing mutual funds
Determine your goals and your risk appetite
What is the reason behind investing in mutual funds? Are you investing to tend to some short term goals, or do you wish to target your long term financial goals with the investment? These are some of the questions every individual must ask himself/herself before deciding which mutual fund to invest in. Also, since mutual funds are market linked schemes that do not guarantee returns, it is equally important for investors to understand their risk tolerance before investing. If you are investing for long term capital gains then equity funds may seem like a wise option. However, equity funds are market linked schemes that heavily invest in the stock market and can even generate negative returns in the short run. On the other hand, if you are looking for a safer option then debt funds may work in your favor, but debt funds do not offer returns as high as equity funds and are usually considered for liquidity. Then there is ELSS (Equity Linked Savings Scheme), a tax saving scheme that comes with a three year lock-in and has a portfolio consisting of stocks of companies belonging to various market capitalizations. Hence, if your goals are clear and if you know how much risk you can take, then investing in mutual funds might become simpler.
Decide which style of investing suits you
Very few investors are aware of the fact that mutual funds are largely categorized as actively managed funds and passively managed funds. Active funds are those mutual funds where the fund manager is the decision maker in terms of buying and selling securities to generate returns and ensuring that the portfolio remains well-diversified throughout different market cycles. Then there are passive funds like index funds and exchange traded funds (ETFs), that are designed to generate returns similar to that of their underlying benchmark by tracking their performance with minimal tracking error. Decide which investment style suits your income needs and invest accordingly.
Decide which plan is more viable for you
Mutual fund schemes come in two plans – growth plan and dividend plan. A growth plan is where the returns generated by the scheme are reinvested back into the fund. This allows the NAV of the mutual fund to rise over time and in turn, appreciate the value of the units owned by the investors. On the other hand, if your goal is to earn regular income through mutual funds then the dividend plan might be more suitable for you. Here, the returns earned by the mutual fund scheme are declared as dividends for the investors. These dividends are deducted from the overall AUM of the mutual fund and may depreciate the NAV of that particular scheme.
Expense ratio and exit loads
Earlier, mutual fund schemes had entry load as well but now that’s been waived off the market regulator SEBI. However, mutual fund investors are subject to an expense ratio that is deducted from their overall gains. Hence, investors must make sure that they consider a scheme with a low expense ratio and one that does not have an exit load either.