If you’re going with inky pinky ponky for choosing mutual funds, it’s time to sit up and listen. There is no dearth of funds in the market clamouring for your attention. It can be intimidating. But choosing a mutual fund is not so complex provided you know all the rules. So let’s look at how we can compare mutual funds to get the best deals.
The first filter is to track the returns to gauge which ones are better than the rest. Returns are the easiest to measure and compare across funds. Simply put, the return that a fund gives over a set period is the percentage difference between the starting Net Asset Value and the ending Net Asset Value. However, just checking returns is not a wholesome approach to compare your mutual funds investments. Returns help you compare between funds on a broad level.
Check for Absolute Returns
Absolute returns measure how much a fund has gained over a certain period. Note down the NAV on one day and re-look at it six months later. Track it over a year or a couple. The percentage difference will give you the return over this time frame. But when using this parameter to compare mutual funds, make sure that you compare the right funds. We all know the adage - don't compare apples with oranges. So in our case, look at the returns of a diversified equity fund and compare it with other diversified equity funds.
Set a Returns Benchmark
A fund's benchmark is an index that is set by a fund company that serves as a standard for its returns. It’s been mandated by the Securities and Exchange Board of India, for funds to declare a benchmark index. The bench marked returns is the standard that the fund targets, and if a fund surpasses this benchmark, it’s deemed to have done well. This index gives you a standard off which you can compare mutual funds. It basically indicates what the fund has earned against what it should have earned. Say, you’ve invested in a diversified equity fund that is bench marked against the Sensex. The returns of this fund will be compared against the Sensex.
Track the Time Period
The period for which you’re comparing mutual funds is extremely crucial. The time period over which returns should be compared and evaluated has to be the same over which that fund type is meant to be invested in. So if you’re comparing equity funds then you must use three to five year returns. Cash funds are uber short-term bond funds or liquid funds that invest in fixed return instruments with short maturities. So it’s all right to compare these funds based on their six month returns.
Market conditions is crucial
It’s important to see if a fund's return history is long enough to have withstood all kinds of market conditions. Say, there are equity funds, launched a couple of years ago and have performed very well. However, such funds have never been exposed to a declining market or a bearish market. So comparing the returns of these funds with the ones that have faced bad markets can be misleading. If your fund has proved its mettle in a bearish market, and has not dipped as much as its benchmark your fund manager is a keeper.
Things you must keep in mind while comparing mutual funds
Checking for returns is your first step
Compare funds that are similar
When returns are compared, make sure that the time period is identical. Else you may be looking at the one-year returns for one fund and the three-year returns for another.
Compare a fund with its own stated benchmark, not another