How to choose a mutual fund for your investment?

A mutual fund is basically a group of investment which are pooled together to be managed by a professional. This is one of the most popular options for investment, as it offers a diverse basket to look into from liquidity, short term to long term benefits at a relatively low cost. Plus, if you are just getting started with investing your money, mutual fund’s mechanism is not even that hard to understand. A basic guide shall make you ready for your first investment. Beyond researching disclosure documents and getting technical, make sure you consider the following points mentioned below:

1. Decide your objective to invest

If you plan to invest your money, there might be two reasons why you decided to do so or thought to do so.

a) You have some idle money - If your money is idle, you can earn returns by investing it for a couple of months to a year.

b) You have a goal for which you wish to accumulate money for - The other reason could be that you have a specific goal to invest your money, its tenure can be for a year or two to as long as 30 to 40 years.

Few goals which you might be foreseeing - International vacation, Car / Motorbike Purchase, Retirement Planning, Education In India / Abroad, Tax Saving, Marriage Plan, Any other goals.

2. Understand your Risk Appetite

Like every investment, Mutual Funds too carry risk. Every category of funds has their own risk associated with them. However, the level of risk in a mutual fund depends upon what you invest in. There are two types of risk to specify here:

a) Risk of having less return than anticipated - Even when everything is done right, there still lays risk of not receiving the expected return, say that you expected 20% but instead got a return of 10%.

b) Having negative returns i.e. negative principal amount - Another risk other than less return is that you might end up getting negative returns where you might end up losing some part of your invested money. This can happen at any point of time during the tenure of your investment.

Don’t forget about the risk and the reward factor! Higher the reward you expect, higher can be risk you undertake. If your risk appetite is low, the returns might be low too.

3. Select a fund according to your objective and risk appetite

After considering and understanding your objectives and risk appetite, next comes to decide which fund category would fit in to achieve your goal / investment.

TIME PERIOD - FUND CATEGORY - RISK FACTOR

1 To 3 months - Liquid Funds (Debt) - Very Low Risk

3 to 6 months - Ultra Short Term Fund (Debt) - Very Low Risk

6 months to a year - Low Duration (Debt), Money Market (Debt) or Arbitrage Fund (Equity) - Low Risk

1-3 years - Short Term / Corporate Bonds (Debt),  Large Cap (Equity) - Moderate Risk

3-5 years - Multi Cap (Equity), Hybrid Equity, Dynamic Bond (Debt) - Moderate Risk

5-7 years - Mid Cap (Equity) or Long term Debt Funds, Credit Risk Funds (Debt) - High Risk

7 years and above - Small Cap (Equity), Sectoral Funds (Equity) - Very High Risk

 Let us understand different fund categories in brief -

1. Liquid Funds (Debt) - Money is invested in instruments such as Certificate of Deposits (CDs) issued by banks and Commercial Papers (CPs) issued by large private companies and NBFCs and Treasury Bills (T-Bills) issued by Government. Liquid Funds do not invest in securities with more than 30 days maturity duration.
2. Ultra Short Term (Debt) - Ultra short-term mutual funds invests in securities like CDs issued by Banks and CPs & Bonds issued by PSUs, large private companies and NBFCs and T-Bills issued by Government, with a maturity horizon from 3 to 6 months.
3. Low Duration (Debt) - Low Duration fund invests in securities like CDs issued by Banks and CPs & Bonds issued by PSUs, large private companies and NBFCs and T-Bills issued by Government, with a maturity horizon from 6 to 9 months.
4. Money Market (Debt) – Money Market Fund invests in securities like CDs issued by Banks and CPs & Bonds issued by PSUs, large private companies and NBFCs and T-Bills issued by Government, with a maturity horizon upto 1 year.
5. Arbitrage Fund (Equity) – Arbitrage fund takes advantage of changing prices of low-risk securities by buying and selling them with calculative moves available in cash and futures market across various sectors.
6. Short Term Funds (Debt) - Short term funds select bonds or debts for investment such that it matures between 1 to 3 years in securities like Bonds and NCDs/Debentures issued by Government, PSUs, NBFCs and other large private companies.
7. Corporate Bonds (Debt) – Corporate Bond is issued by public sector companies or private companies and is sold to investors for various reasons to generate cash by investing at least 80% of its total assets in the corporate bond.
8. Large Cap (Equity) - Large caps select stocks for investment from the largest / highest market capitalization stocks listed in Indian Market which are expected to be less risky than mid or small cap stocks.
9. Multi Cap (Equity) – Multi Cap invests in stocks across market capitalization. That is, their portfolio comprises of large cap, midcap and small cap stocks. They are able to take advantage of the opportunities across markets for the investment.
10. Hybrid Fund - Hybrid funds invest in a mix of asset classes. In some cases, investment in debt is higher than in equity and vice versa. Equity-Oriented Hybrid Fund invests 65% of corpus in equities and the rest in debt while Debt-Oriented Hybrid Fund invests 65% in Debt and the rest in equities. This helps to balance out the risk and the return and is considered safer than pure equity funds.
11. Dynamic Bond (Debt) - Dynamic Bond Funds are debt funds that alter allocation between short term and long term instruments like bonds and debentures issued by Government, PSUs, NBFCs and other large private companies usually for a tenure of 3 to 5 years to take advantage of changing interest rates.
12. Mid Cap (Equity) - Mid-cap fund invest in stocks focusing on the market capital in the middle range of listed stocks. These midcap companies tend to provide more growth potential than large cap stocks.
13. Credit Risk Funds (Debt) - Credit risk fund is a debt mutual fund which invests at least 65% in lower than AA-rated instruments like bonds and debentures issued by private companies which have a potential to grow and give higher returns.
14. Small Cap (Equity) - Small cap selects stocks from the small market capitalized stocks and are suitable for long-term investment.
15. Sectoral Fund (Equity) - Sectoral funds invest in particular sector of the market or funds which fits in specific theme (Eg. – Infrastructure Sector, Pharma Sector), and the returns are tied to the performance of the chosen sector.

Let us discuss some goal-based funds examples -

1. If you want to plan a holiday/vacation with your family, which is say 2 years from today, it is a short-term goal and thus you can use a combination of corporate bonds and arbitrage funds. If you have 3-5 years, a conservative hybrid fund would be appropriate for you.
2. If you are planning for higher education for your child who is of five years age now, you have 12 to 15 years which makes it a long-term goal. A combination of various funds for a long term goal helps get good return. For example, investing in equity funds - multi-cap, small-cap or mid-cap funds.
3. If you are 30 years old and you plan to retire at the age of 60, you have 30 years, which is a long-term goal for which a small cap, hybrid funds, multi caps would be suffice based on the risk you can undertake.
4. For your Tax Saving goal, invest your money in Equity Linked Savings Scheme or more conveniently called as Tax Saving funds which essentially are multi-cap funds with a 3 years lock-in period. This is best-suited for long-term and salaried investors.

While selecting fund categories you can have a combination of two or more fund categories also best suitable to your needs and for diversification.

4. Select AMC and the fund scheme

Once you are done understanding your investment objective, risk appetite and have selected your fund category, the next step is to select the Asset Management Company.

The first thing to consider before selecting the AMC is their AUM (Assets Under Management) is, the higher the AUM figures the better is the management as it signifies that they are well established in the field. However, you may consider other factors too like their managerial experience, track record of the past performance, what kind of returns has the manager achieved in the past? Past performance certainly isn’t a predictor of the future, but it helps you understand their investment style and the kind of conditions in which fund manager outperforms the market.

Conclusion -

Once you are done organizing and answering these questions, you are ready to start with investing in Mutual Funds!

However, it is always recommended to have a professional financial advisor/expert to manage your money; especially if you’re not market savvy. The advisor may charge nominal fees for the service they provide which shall be worth the entire process. With the help of a financial advisor, reach your goal and be in a better financial position.

Disclaimer -

Mutual fund investments are subject to market risks. The information and views do not guarantee fund performance, nor should they be viewed as an assessment of a fund or the fund’s underlying securities’ creditworthiness. Please read the scheme information and other related documents before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements before choosing a fund, or designing a portfolio that suits your needs. The information provided above is generic views for a layman to invest in mutual fund and should not be construed as a recommendation.