5 FACTORS TO CONSIDER BEFORE INVESTING IN MUTUAL FUNDS

We all have heard of the famous ad campaign of AMFI (Association of Mutual Funds in India) ‘Mutual Funds Sahi Hai’, but there are 44 AMCs in India and more than 2500 schemes offered by these AMCs and most of us are not aware of the factors to be considered before investing in mutual funds from the pool of mutual schemes. So, we have devised a list of five factors to be considered before investing in mutual funds.

GOAL

This is the most important factor that needs to be considered by potential investors of mutual funds. As the investment goal, purpose, risk-bearing capacity, and income levels of every individual may vary differently, some can take more risks with their investments and invest in equity funds for higher returns and some can take a different approach like investing in debt funds which are less risky than equity funds in exchange for lower returns. Considering the age factor is also important to be taken care of, as a young individual may invest in equity funds and stay for long with the course of investment and rip the benefits of compounding which will eventually create a bigger corpus. On the other hand, his older counterpart may not be able to invest in equity as aggressively because of his liabilities and commitments and have to park some of his savings in Debt funds. Investment in Mutual funds is ideally done with certain purposes in mind like buying a house & car, retirement fund, etc. which will take us to the question ‘How much money do we actually need at the end of the investment horizon’ considering factors like inflation and living standards of the individual. In short, it solely depends upon the investor and his current state.

RISK ANALYSIS

There are some parameters to measure the risk of a mutual fund like Beta, R Square, Sharpe ratio, Alpha, Standard Deviation, Sortino ratio, and many more but the idea is not to intimidate with technical jargon but to give a glimpse of your financial advisor’s work before suggesting you a mutual fund scheme. For starters, past performance is an indicator that gives us information about the return generated by the fund but there is a catch to it as past performance is sometimes misleading. You may ask HOW? The answer lies in the details of the return, as mutual fund returns are generally annualized. To get a better understanding, let us take an example, a mutual fund giving a return of 12% per year up till now doesn’t mean that it will give the same 12% return every year because returns of mutual funds are not linear. It may happen that the same fund would give a 15% return in year 1 and -3% return next year. So, it is advisable to look at the details before jumping to any decision.

CONSISTENCY

Consistency of return should also play an important role in your decision-making process. A scheme generating a return of 10% over a period of time and being consistent is much better than a fund with a return of 18% in the past but is underperforming now. As investors generally stay invested in mutual funds for a longer period, investing in a fund that generates inconsistent returns may not be wise as it will substantially reduce the corpus at the end of the investment period. So, it is advisable to invest in a consistent performing fund.

COST AND TAX IMPLICATIONS

Starting with cost, the expense ratio (Small amount of charges by AMC in exchange for services offered) is the most important one. Equity funds have an expense ratio of 1.5-2% while index funds have much lower expense ratios. Another cost associated with mutual funds is exit load, which is basically a fee charged by AMCs while exiting the investment or redemption of mutual funds unit but then it may vary among different AMCs and mutual fund schemes. It is also possible that some schemes may not have an exit load altogether. Moving on to tax, let us understand through an example, if you sell equity funds before a period of 1 year, they attract STCG tax at 15% while debt funds sold before 3 years will attract STCG tax according to the investor’s income tax slab rate. Similarly, equity funds LTCG gains were tax-free up till April 01st, 2018; however, changes were made in regards to implications and any gains in excess of Rs.1 lakh will be taxed at a flat rate of 10% without the benefit of indexation.

EXPERIENCE OF PORTFOLIO MANAGERS

The experience of the portfolio manager is also an important factor to be considered before deciding on investing in a mutual scheme, Investors should have some questions like Who are the portfolio managers? How much experience do they hold? What is the performance of funds managed by them in the past? You may ask whether it is necessary to have these questions in our mind, and the answer would be yes because they are the ones who are going to invest your hard-earned money in different financial instruments and put their know-how and experience to generate returns and make your corpus bigger over a period of time.

For most of us, investing in mutual funds with the appropriate approach can be a difficult experience, but having a complete understanding is essential since it puts the investor in control. The aforementioned aspects would have undoubtedly made life easier, but believe us when we say that this is only the tip of the iceberg and that there is still much more to learn. This is where we come in to help you make a more informed investment decision by offering information and data on various financial instruments.

Analysis by - Rajat Singh