Mutual funds are one of the best ways to invest in a disciplined manner at a lower cost and with professional management. It helps you invest easily in equities which is a solid recipe for long-term wealth creation. But with so many options out there, how do you really know which one is right for you? In this piece, we will at the 10 most important questions you should ask yourself before investing in any mutual fund scheme.
What are my investment goals and time horizon?
Goals help you define the duration of your investment and the amount you would need to save. This in turn helps your investments gain direction and helps you choose the suitable type of scheme and the amount of SIP. Your financial goals can be to save for your retirement, child’s education, vacation, business seed capital, house purchase, etc.
What is my risk tolerance?
Mutual funds carry different levels of risk depending upon the type and investing style. Hence, you must also understand your risk profile i.e., your ability and willingness to take financial risks. Equities are riskier compared to other asset classes; hence, risk-averse investors should minimise their exposure to equities. Investing as per risk profile can help you as you will less likely make decisions based on market volatility and stay the course. Conservative investors holding riskier funds may not be able to get the proper benefit of these funds as they are more likely to redeem or switch or stop investments during high volatility.
What types of mutual funds align with my goals (e.g., equity, debt,
hybrid)?
There are various mutual fund schemes available in the market. A pure equity scheme may not be suitable for you if you need the money before 5 years. Similarly, debt funds aren’t the right choice for investments that will be long-term. You should construct a portfolio and allocate funds in it based on your risk tolerance and the time horizon of your goal.
What are the past performance and track record of the fund?
Studying the scheme’s historic performance & risk management measures can give you an idea of the fund management expertise of the fund manager (s). Compare similar schemes in the category after you have chosen the type of fund most suitable for your goal. Take SIP returns, trailing returns, rolling returns into consideration along with risk measures like standard deviation and beta (lower the better). Risk-adjusted measures like the Alpha, Sharpe ratio and Sortino give you more insight into the returns generated by funds for the risks taken. A higher ratio is preferable. Past performance of a mutual fund doesn’t guarantee future performance but can give you immense insight and help you manage your expectations regarding risk and returns.
What are the fees and expenses associated with the fund?
The funds TER or total expense ratio is an annual charge deducted for managing and running the fund. Lower expense ratios should be preferred as it translates to more return in the future. You should compare the TER within the category to choose funds that offer a balance of better fund management and lower fees. Index funds tend to have the lowest TER due to the passive investment strategy.
Who is the fund manager, and what is their investment strategy?
Understanding the fund manager’s background, education, experience, and investment approach is crucial. Are they known for active management or passive strategies like index tracking? How do they manage risk and capitalize on opportunities? How long have they been managing the fund? A fund is generally managed by multiple managers and much of the active decisions on what the fund will hold, sell, or buy will be taken by them.
What is the fund’s asset allocation?
Asset allocation refers to how the fund distributes its investments across different asset classes such as stocks, bonds, cash equivalents, and possibly others like commodities. This allocation affects the fund’s risk and return profile, so it’s important to know how it aligns with your investment goals and risk tolerance.
Are there any exit loads or penalties for early withdrawal?
Equity funds primarily have exit loads for early withdrawals in the first 12 months of investments – it can go as high as 1%. These loads are applied to deter investors from short-term investing and withdrawing funds during market volatility. You should check the minimum investment tenure before you can freely withdraw the units.
How did the fund perform in different market conditions?
How did the fund perform in markets periods which were not favourable– that is periods where the overall market was very volatile or bearish or flat. For equity funds, you should see periods when the market sentiment was bearish in the Indian market – 2000-2003, 2008-2013, 2015-2016, COVID, etc. How did the funds navigate these periods? A good funds should have dealt these periods by minimising drawdowns and generating returns better than the overall market.
What is the minimum investment required for the fund?
How much can you invest in the fund? what is the minimum SIP amount? Does it allow lump sum investments? Most of the funds allow lump sum investments and monthly SIP without any restrictions and it will not be a problem. But some funds may limit SIP amount and lump sum investments due to market scenario and regulatory measures and others limit frequency of SIPs. Checking these details can help you select funds as per your personal circumstances.
Final Words
Mutual funds are effective investment vehicles for your financial goals. Choosing the right fund for yourself is primarily about understanding your financial goals and risk appetite. Asking yourself these important questions can help you narrow down your investment choice and choose the right fund.
