Mutual funds are not risk free, but they manage risk admirably well
A lot of investors tend to equate mutual funds with a risk-free method of creating wealth in the future. That is not exactly correct! Mutual funds just manage risk a lot better by combining professional management, regular investing, better stock selection and the smart use of time rather than timing. If chosen carefully, some of the mutual funds (MFs) actually have the capability to double one 's wealth over the long term. However, selecting the best mutual fund, and more importantly to choose the fund that meets your requirement becomes a lot more complex. More so, considering the plethora of plans, schemes and funds available in the market! Here are 7 important things you need to necessarily know before you invest in mutual funds.
7 things to know before investing in mutual funds
We are taking a look at top 10 things which you must check before investing in a mutual fund:
1.How important is pedigree and length of existence. It is always better to go with the tried and tested names that have stood the test of time. As the old saying goes, a known devil is always better than an unknown angel. One must ensure that the mutual fund you are planning to invest in has been in existence for a period of at least 15 years in the Indian market. This will ensure that they have lived through multiple cycles of the market.
2.The qualifications and the longevity of the fund manager also matters a lot. Do a quick check on the experience of the fund manager and their past performance. A fund manager or CEO who holds the team together is more likely to have a stable and reliable fund management policy and philosophy.
3.Assess the AUM (Assets under Management) of the fund. It is not necessary that only large AUM funds are good. However, a reasonably large AUM of over Rs.1000 crore will tell you about the ability of the fund manager to manage scale and will also ensure that your Total Expense Ratio (TER) is lower due to the economies of scale.
4.Check the investment allocation and the portfolio mix of the fund. You do not want an equity fund that is taking too much risk in mid caps and small caps. You also do not want a debt fund manager who is shooting from the hip with too much exposure to low credit instruments. The portfolio of the fund says a lot.
5.Returns and past performance is important although the risk factors state that they do not reflect future performance. For example, a fund that does not take on unnecessary risk or a fund that has concisely beaten the index or a fund that has shown consistent annual performance are better bets.
6.Look at the cost of the fund in the form of entry and exit loads. Entry loads are banned but you are still billed the TER on a daily basis. When you compare two similar funds, opt for the one with the lower TER. Also consider the volatility costs. You cannot be hooked on to funds that generate higher returns but with a proportionately higher risk. Look at measures like Sharpe and Treynor in equity funds and the duration risk in debt funds before investing.
7.Last, but not the least, apply the suitability test to the fund. The best funds are not good enough if your goals are not going to be met by the fund. A debt funds is pointless for generating wealth over the long term. Similarly, in the short term if you have a payable in the next 3 years, then an equity fund could be just too risky. When you select the fund look at how it fits into your overall scheme of things in terms of returns, risk, liquidity requirements and in terms of tax efficiency.
Applying the above 7 rules is a good starting point to select the right fund for the right goals. After all, mutual funds do offer the flexibility to meet a variety of life goals.