How To Select Mutual Funds

Introduction

Today, we are discussing how to select mutual funds. Mutual Funds are investment companies, which take money from investors and gather them as capital. Every Mutual Fund has its fund manager. The fund managers are professional and experts in investing the money to get back maximum returns. They calculate and invest the accumulated amount of money in different assets like stocks, bonds, commodities real estate, etc. An investor buys the share and owes a part of the interest of the asset.

These investments are very advantageous due to their diversified nature. In general, mutual funds hold various stocks, and this diversification reduces the risk of loss. Also, mutual funds are very liquid, so buying and redeeming shares are quite easy. Experts say that young professionals must consider investing money as early as possible to generate high returns in the long term while minimizing risks.

But, the most prominent doubts of investment for beginners are deciding where to put their hard-earned money in, how to select the best suited mutual fund, how to judge a mutual fund that will help to reach an investor’s financial goal. So many doubts and quarries, well this article will help you to judge and make the right decision to invest in mutual funds in India.

First, you need to know what Mutual Funds are, how they work, their types, and their features. To know, we have an entire article on that, just visit Types Of Mutual Funds In India – Everything About Mutual Funds To have a clear concept of mutual funds.

Must considerable factors Before investing

Own mindset and capability

Now after knowing about mutual funds, know your financial goals and risk-taking capability. Some mutual funds are suited for short-term goals whereas, some are best for long-term. It could be a quick capital gain for something to purchase or higher studies expenses, whether your goal could be the retirement plan which is many years far. So, think of the objective you want to reach.

It Different investors have the different risk appetite, some are comfortable with low or no risk at all but, some do bet for high risks. So, before taking any further steps make a judgment. If not feeling confident enough, take help from a professional or experienced investor.

Knowledge

It might be frightening if you want to invest in mutual funds but, someone says that you need to understand the market, stocks, or bonds. Let be clear, if you manage your investments by solely yourself, then you need to understand the trading know-how. Any professional knows and that is the reason they are experts at it. But, if you invest in mutual funds just to reach your financial goals, then you don’t need to be an expert in the stock market. It would be enough to know what kind of mutual fund serves which purpose.

Portfolio diversification or selecting the type/style of investment

Depending on the choice of investment if you want capital appreciation and invest for the long term with a fair amount of risk and volatility, long-term capital appreciation funds would be the right choice for you. Long-term funds hold a huge percentage of assets in common stocks. As result, these funds are risky but do possess the potential to provide high returns over a long time. In general, these funds hold time bounds of 5 years or more.

On the other hand, if you need quick income then income funds would be the perfect choice for you. These funds invest in bonds or debt instruments that pay on regular basis. These funds are less volatile depending on the bonds but, these funds also narrow the scope of investment in terms of categories, and periods are classified as short, medium, or long term.

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However bond funds carry risks like,

1. Interest rates are sensitive to the changes in bond prices. When interest rates go up, bond prices go down and.

2. Issuer could have credit rating lowered resulting in possible credit risk. This risk adversely impacts the bonds price.

3. Bondholders pay off the bond principal early to take advantage of reissuing their debt at a lower interest rate, this is known as prepayment risk. Investors are likely to be unable to reinvest and receive the same interest rate.

Adding these funds creates diversification in the portfolio. But, sometimes investors want to invest for the long term but, not willing to take risks. In simple words, if you want the advantages from both short-term and long-term funds, then balanced funds would be the best choice.

Loads and Charges/Fees

The fund house needs to make money as they are putting your money by calculated decisions and returns you with profits. You don’t need to think of the right place to invest as the fund houses are doing it for you. So they do it by charging fees.

So, it is very necessary to know about different charges/fees before you invest in a mutual fund.

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Let’s discuss these charges,

Front-end load

Some funds charge a sales fee known as a load. It will either be charged at the time of purchase or upon the sale of the investment. This fee is paid out of the initial investment when you buy shares in the fund. Front-end loaded shares are identified as Class A shares. Front-end loaded funds typically charge 3% to 6% of the total amount invested or distributed, but this figure can be as much as 8.5% by law.

Back-end load

The fee is charged when you sell your shares in the fund. The back-end load typically applies if the shares are sold before a set time, usually five to ten years from purchase. This charge is intended to deter investors from buying and selling too often. The fee is the highest for the first year you hold the shares, then dwindles the longer you keep them. Back-end loaded shares are identified as Class B shares and these funds typically charge 3% to 6% of the total amount invested or distributed which also can be as high as 8.5% by law.

Level load fee

The level load is an annual charge amount deducted from assets in the fund. Class C shares carry this sort of charge.

Expense ratio

Some funds do not charge a load fee, these are known as No-Load Funds. But, they do charge an Expense ratio which may be very high. The ratio is simply the total percentage of fund assets that are being charged to cover fund expenses. The higher the ratio, the lower your return will be at the end of the year. 

12b-1 Fees

Some funds charge these fees which are baked into the share price and are used for promotions, sales, and other activities related by the funds to the distribution of fund shares. These fees come off the reported share price at a predetermined point in time. Hence, investors may not be aware of the fee at all. By law, these 12b-1 fees can be as much as 0.75% of a fund’s average annual assets under management.

Passive & Active Management

Funds that are actively managed have portfolio managers to decide which securities or assets need to include in the fund. These professional experts study and research the assets and select sectors depending on company fundamentals, economic trends, etc. Before making investment decisions. These funds seek to outperform a benchmark index, depending on the type of fund. Hence, fees are often higher and Expense ratios can vary from 0.6%-1.5%.

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Passively managed funds are known as Index Funds. These funds track and seek to duplicate the performance of a benchmark index. As a result, the fees are generally lower than the actively managed funds, with having expense ratios as low as 0.15%. These funds do not trade their assets unless the benchmark index changes. Passively managed funds may have numerous stock holdings, resulting in a diversified portfolio. But, as they do not trade very often, they do not create much taxable income which is important for non-tax advantaged accounts.

Performance & Management history

It is very crucial to research the fund’s history. The management and performance on the part of the fund show the present result.

So, a good performance history can be evaluated by checking these factors like,

  • The fund manager should need to deliver consistent results compare to the market standards.
  • The fund should need to stable and less volatile than major indexes.
  • There shouldn’t be any unexpected high returns in the past that effected cost and tax liabilities for investors.

Try to find out these quarries and you can get an overall history and expect more accurate from that fund.

Income or Growth

You can generate 2 types of income through mutual fund investments, Capital gains & Dividends.

If, your objective is to gain wealth over a longer period and has no intention of quick income then, funds those aim on growth stocks would be preferable for you. These funds use to buy and hold strategy, also possesses low expenses and tax effect than other fund types.

But, if you want a regular income from your investment, then dividend funds would be nice to choose for investment. These funds invest in a variety of dividend/interest-bearing stocks that pay dividends quarterly, semi-annually, or annually.

Tax

A very important consideration before investing in any particular mutual fund. The higher income annually the higher taxes get, and sometimes it can create a serious impact on investors.

Some facts are like,

1. Dividend funds are not so great to minimize tax liabilities. Any dividend payments increase the taxable income of an investor for the year.

2. Some funds invest in tax-free government or municipal bonds, which generate tax-free interest. But, all tax-free bonds are not completely tax-free, so it is important to verify those earnings whether subjected to state/local taxes or not.

3. Some funds are managed with particular tax efficiency aims. These funds typically use buy and hold strategy and strictly avoid dividend-paying securities.

So, the best to choose funds that focus on long-term capital gains and avoid dividend stocks or interest-bearing corporate bonds.

Do’s

Every investor should follow a strategy by themselves or invest in mutual funds that follow investment strategies in favor of the investor.

Value Investment

It is one of the most well-established, widely used, and respected stock market investing strategies. Buying stocks during the market falls by identifying companies with genuine value, mostly when specific stock prices were either undervalued or at the very least.

As a result, these stocks won’t prone easily to a dramatic fall. The metric used to identify these undervalued stocks is the Price-Book(P/B) ratio. Investors who do value investors prefer to see P/B ratios at least below 3, and ideally below 1. Although, this ratio can vary from sector to sector or industry. But, a company’s P/B value compare to similar companies engaged in the same business is an evaluation factor.

Valuating can be done beyond considering the P/B value. Companies are considered valuable if they have strong cash flow, minimum debts, products or services offering, and how they project themselves in the market.

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Contrarian Investment

In this strategy, investors go against the prevailing market sentiment or trend. Contrarian investing is selling short or at least avoiding buying specific stocks when experts across the board are all projecting above-average gains for companies in the specified industry.

In simple words, contrarian investors do the opposite of what is done by the majority of investors. They buy when the majority is selling and sell when the majority is buying. The reason is contrarian investors buy stocks that are out of favor or the prices have declined.

However, this strategy requires knowledge and expertise. There are plenty of contrarian mutual funds available in the market where investors can find contrarian-style funds to invest in sectors that have been underperforming for several years. Hence, expect that the sector will experience recovery and turn upwards.

Momentum Investment

The main focus of Momentum Investment is to gain profit from existing market trends and the approach is close to growth investments. A good Price-Earnings to Growth ratio and increase in the fund’s Net Asset Value(NAV) every year show the stability and strong holding of the mutual fund in the market.

Mutual funds that follow momentum Investment strategy can be identified by the fund description. The fund manager aims for momentum Investment while selecting stocks and creating a portfolio. Investors can do research and select funds that perform momentum Investments and can analyze the momentum performance to understand and select the right choice for investment.

You can check a fund’s history by checking the NAV of the specific fund. Suppose, if the NAV rose by 3% in the past 3 years, 5% by the following years, and 7% in the recent year, then that particular fund has a strong momentum history. After a little bit of research and you will find a suitable mutual fund that offers great exposure in momentum Investments. Also, you can invest by yourself solely after selecting particular sectors or industries to invest in with such an approach.

Myths

As you are now well aware of mutual funds, selection, and you’re doing. It is also important to know about some popular myths that generally distract investors and somewhat leave them in dilemma regarding mutual fund investments.

Risk

Mutual funds are not bet. Yes, it runs on a prediction but, not just in random. Mutual funds are calculated expectations assumed by performing market studies and extensive researches. Each kind of mutual fund is different from one another and carries its own set of risks. Investors need to judge and calculate their risk appetite before making investments.

High rated funds are best

It is not always the case. Funds do get higher ratings depending on the performance and keep in mind that evaluated performance is history. It couldn’t guarantee the future. A good track record shows consistency and expertise of the fund and fund management obviously which creates trust. But, it is always advisable to diversify your portfolio to minimize risk and loss in any unfortunate scenarios.

Mutual funds are not for everyone

The most common myth is mutual funds are for rich persons or experts who have accounts background. Well, it is wrong.

Anyone can start investing in mutual funds. Investing doesn’t require either any special knowledge that you need to do a course on or having an accounts background. Simple and basic know-how can help you start investing and gain good returns.

And it is not only for rich people also, but you can also go online and start SIP(to know about SIP, visit SIP Meaning – SIP Calculator, Benefits, Returns To get a complete idea) investments in mutual funds as low as Rs. 100 only. The only factor is public awareness, if you are willing to invest then you should find ways to do so.

Conclusion

As inflation rates are skyrocketing, it is necessary to maintain your wealth standards matching up to date. However, people choose savings accounts to save their earnings or do fixed deposits. But, these are not going to increase your wealth. Let the money work for you.

The famous quote “mutual fund investments are subject to market risks, please read all documents carefully before investing” is surely frightening, but it is only frightening because of the lack of public awareness. Some basic knowledge can make you a successful investor. Mutual funds have the potential to grow wealth over a long period if invested wisely.

We hope our post will be helpful for your future investment and clear all the doubts regarding mutual funds as well.

All the best and happy investing.

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