Mutual funds are financial vehicles that are essentially an amalgamation of funds from investors pooled together. They are managed by professional fund managers who invest in various assets like money market funds, stocks, bonds, and other assets. Here’s where you can learn more about Mutual Funds in detail.
The diversified nature and the expertise of these fund managers make mutual funds a great addition to one’s portfolio. An investor investing in a mutual fund is essentially betting on its performance which, in turn, is based on the aggregate performance of all the assets the fund invests in.
So which one should you invest in? How do you choose? Here are two questions you should ask yourself before picking a mutual fund:
- What are your goals and what is your risk appetite?
The very first steps are to understand what your long-term and short-term financial goals are, how much risk your portfolio can manage and where your comfort zone is. You need to ask some important questions related to your financial goals so that you can narrow down relevant choices in this wide array of potential options.
Are you looking for some income in the immediate or in the short term, which would indicate your current income? Alternatively, are capital gains in the long-term something that suits your style? Index funds are great if you can invest for more than a decade. Understand your preference for your time frame. What goal are you aiming to achieve: a world tour, college education or your retirement, perhaps? Then comes the question of your risk tolerance: can you withstand sways between highs and lows in your portfolio or are you, somewhat, risk-averse and are comfortable with a conservative investment strategy? Now is also a good time to recall the golden rule of finance, which states that risk and reward are directly proportional.
- Which metrics should you look at?
Before your money is even invested in securities, it is first used to run the investment firm in the form of paying analyst salaries, paying bills to run the firm and other operational costs. All these expenses are factored into the expense ratio. As an investor, an expense ratio can be viewed as a cost of the ownership stake in the fund. You must target funds with relatively lower expense ratios. As a percentage, it might seem small but blanketed over the entire investment portfolio, it has a significant impact.
Usually, the size of the fund isn’t something that’s really given much attention and for a fair reason. However, large funds with over $80 billion are something you should avoid, as it becomes too large for the managers to control it effectively.
Taxes are another aspect you should focus on. When securities are sold, their capital gains are taxed. Hence, it is important to factor in the turnover rate. Turnover rate is that percentage of the portfolio that is bought and sold each year and if the turnover rate is higher than 50%, steering away would be a better idea or else, taxes might end up eating a big slice of your pizza. If you're investing from a tax-free account, you need not worry.
Watch out for exit and entry loads (sales loads); they are the fees charged when you start investing in a mutual fund and the fees charged when you exit it. They are usually around 5% of the amount invested and this is a good way to earn money if you are a fund manager. But as an investor, try not to invest in such funds, as they effectively reduce the sum of money that’s working for you.
Let’s say we have ₹50,000 to invest and the entry load is 5%. Then, you will be charged a fee of ₹2500 and ₹47,500 end up being actually invested. Thus, invest in funds that don’t charge a sales load.
- What kind of fund do you want?
You also need to determine whether you want an actively or passively managed fund. Active funds generally have higher fees and aim to beat the performance of benchmark indices. Passively managed funds try to match the performance of the benchmark indices like the NIFTY 50 and the fees are relatively lower. Make sure the team managing the fund is disciplined and has a respectable degree of expertise. Looking at star ratings to pick a fund isn’t a good idea but it’s definitely a starting point.
Everyone is different and have different ideologies and preferences. To find a good fit, make sure your philosophy aligns with that of the fund. There are people who just invest in blue-chip funds, there are value investors and there are individuals who like to invest in socially responsible funds. Thus, the end goal is picking what you like.