Follow These Simple Rules to Select the Right Mutual Fund | Motilal Oswal

Rules to Select the Right Mutual Fund

You could call them tips and tricks or rules, but if you follow certain ways of investing, you can pick the right investment for your personal needs. Perhaps the most looming challenge that investors face in current times is the plethora of investment choices at their feet. Over and above that, if you do zero in on one single instrument, there is a range within the category to ponder on. You may just get fed up and go in for day trading, but this, too, requires some amount of research, not to mention, skill. In India, today, there are some 40 or more AMCs that offer mutual funds, and some 1000 funds and above. The numbers are only rising as more and more investors are drawn to a mutual fund above any other investment. 

Why Choose Mutual Funds?

As you know and have heard many times over, stocks are very popular as investment securities. For those indulging in stock trading, be it clever day trading, or using a buy and hold strategy, many traders will talk of how lucrative the markets are. However, there are many stories of loss too, as there are two sides to every coin. If you open a demat account and are caught by the bug of trading in stocks, but are wary of the potential risks, mutual funds may be balanced investment instruments for you. Furthermore, you may have invested in some stocks, but want to diversify your portfolio by going at investment in stocks a second time around - this time, not taking too much of a risky chance. 

A mutual fund is a good way to invest as it pools your capital with that of other investors and then invests in a bundle of stocks. The fund is run by a fund manager who selects funds based on any given investor’s needs. In this way, a mutual fund could be tailor made for you. However, the choice of a fund should never be left to someone else. Some simple and straightforward rules can help you make your mutual fund choices a lot easier than if you had no guidelines to bank on. 

The First Rule

The idea of investment is to make it as profitable for the investor as possible. Investors walk into investment with the thought that if they invest in a number of schemes, their capital is bound to multiply. A premise such as this is based on the fact of quantity of investments with little attention paid to quality. Consequently, even while investing in any upcoming IPOs, instead of investing in just one upcoming IPO which is robust in nature and historical growth, you may find enthusiastic investors clamouring to apply to a few. 

Any novice to the concept of a mutual fund should ideally limit their investment to a single scheme. Moreover, this should be done in each of the categories of major equity mutual funds. For instance, a good idea would be to select a good large-cap scheme, one multi-cap, and two small or mid-cap plans. Why two small cap or mid cap funds would be sensible is because these would benefit investors from owning stock  across segments. Hence, if one category does badly, the others act as a hedge to mitigate risks. 

The Second Rule

You may not be interested in mutual funds at all, and not everyone has got onto this wagon of investment. However, jumping into the stock market and applying strategies of, say, day trading, or simply buying and selling stocks, is not for everyone. The great risk takers of this world may be prone to stock trading, but even the cleverest traders have experiences of losses at the exchanges. Assessing your risk appetite is a prudent way to get ahead with your investment channels. Mutual funds may suit you if you want to balance your risks. 

The Third Rule

It is not wise to select more than two funds arising from a single category. You may find that many schemes are good performers, but restrict your urge to owning a lot of mutual fund schemes belonging to a single class. If you do this, you will lack the ability to achieve diversification and hence, maximisation of returns. Essentially, all you would be doing is replicating investments, and there could be portfolio overlapping taking place. Typically, you will find identical stocks appearing in funds of many schemes. Hence, if you don’t tread with care in terms of choice, you end up with very little balance in your investments. 

The Fourth Rule

In case you see yourself as a DIY investor in mutual funds, it is prudent of you to steer clear of a mutual fund that invests in sector funds. You might find it challenging to time the entry and the exit in such funds in order for you to get good returns. Furthermore, with the ownership of solid and diversified schemes of equity, your exposure to a sector that is performing well could be sizable. Retail investors should avoid funds that are related to sectors and if related to any sector, the investment should not exceed 5%. 

The Fifth Rule

When it comes to investment, whether you are a day trader or a mutual fund investor, the word “risk” is always wandering about. Individuals who invest in mutual funds are drawn to funds that are performing at the top. Investors have a habit of adding funds to their baskets without checking details of funds. The top performing funds don’t necessarily mean those that match any given risk appetite. Adding funds with different securities that may be “performing well” may not do so well if there is a turn in the markets suddenly. The rule, consequently, is to choose schemes that fit your risk profile. 

Rule-based Investment

You may open a demat account today to invest in the stock market, or may go in for any upcoming IPO. You can have a diverse group of instruments and investment products to truly make your portfolio varied. Mutual funds should be on this list, and you can gain from them, provided, as with any investment, you follow structured rules and guidelines. 

 

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