UNDERSTAND HOW TO CHOOSE MUTUAL FUNDS
There are several types of mutual funds available to an investor. For some, this vast universe of available products might seem too overwhelming. This article will walk you through about selecting the best mutual fund for your portfolio. You can choose mutual funds based on numerous parameters such as past performance, expense ratio, risk profile, asset under management, experience of the fund manager, etc. Let’s look at some of these points:
- Compare your scheme’s performance against the benchmark
Compare your fund’s performance against a benchmark is a good practice that should be adopted by investors. However, while comparing, make sure that you use a fair and appropriate benchmark. In short, it should be an apple to apple comparison. Using the wrong yardstick can produce misleading data which can hamper your returns. For instance, for a large-cap equity fund, the correct benchmark could be Nifty 50.
- Understand your fund’s expense ratio
Expense ratio is defined as the annual fee charged by the fund house or the AMC (asset management company) for managing your mutual fund investments. As per the Securities and Exchange Board of India (SEBI), fund houses can not charge more than 2.5% as the total expense ratio. Expense ratios are levied out of returns on mutual fund investments. So, the higher the expense ratio of a fund, the lower would be your take-home returns. So, make a habit to always check for the expense ratio of a fund before finalising on it.
- Compare fund history
A mutual fund’s real worth is evaluated only during unfavourable market conditions, and a fund history is a testament to that. Look for a mutual fund scheme that has a fund history for a longer duration, say 5 to 10 years. Compare the fund history across different business cycles, market conditions, and time intervals. For example, a fund has delivered a consistent performance which is in line with the expected returns during a market rally is a good one. Additionally, during a market slump, if it lost 5% returns while the benchmark lost 8% returns, then the fund has done significantly well.
- Compare risk-adjusted returns
Instead of factoring just annualised returns of the fund, consider risk-adjusted returns. As per risk-return trade-off, a higher level of risk should be compensated with a higher degree of profits. The risk is calculated with the help of a standard deviation. Using the Sharpe ratio, you can ascertain whether a particular fund is giving higher returns on every additional unit of risk adopted. The fund having a higher Sharpe ratio than the category average means that the fund manager has delivered higher returns for the extra risk taken.
Always invest in mutual funds taking your risk profile and personal goals into mind. For instance, if you have a low-risk profile, you might consider investing in debt funds. However, if you are looking for diversification, go for hybrid funds- that provide you with the best of both worlds –debt and equity. Happy investing!