Mutual fund investment is one of the most frequently used investment tools in this generation. It is a method of investment which can help you earn a solid return. However, novice investors often find it tricky to get going, as they are unsure as to how to approach the selection of mutual fund phase. This process need not be as challenging as many make it out to be. All you need is due diligence to pick the best mutual funds suitable to your needs. Apart from this, a little fine-tuning of other minor aspects and you should be good to go.
Basics of Mutual Fund Investments
Before you begin the process of mutual fund selection, there are a few things that you need to be aware of. First things first, you need to be clear as to what are the financial objectives that you wish to achieve with the mutual fund investments. Once you are clear about that, you will also need to set your limits as to how much risk you are willing to take, in order to achieve this/these financial goals and in what time period.
The fundamental aim when picking mutual funds is to buy the mutual funds that offer the best returns at the lowest prices. However, if you want to get the best out of your funds, then you must devise a strategy that has the capacity to enhance your portfolio and investment objectives.
Once you have shortlisted the mutual funds, you should not rest easy. You should analyse the performances of the funds further check their recent performances, trends, expense ratios and its management team, etc. It is also a good idea to involve different types of investment strategies which can drive your choices of funds. Some of the ways to do that include diversification of portfolio through international exposure, rupee-cost-averaging the money into several funds or buying the market index.
Now that we are clear on the things that we need to do to select the best mutual funds for your portfolio let us discuss some of the tips that can help you make the best possible decisions –
- Set Your Goals and Determine the Risk Tolerance Level
As an investor the sheer volume of options available today can be mind-boggling. There are as many as 10,000 options to choose from, which can be confusing for the investor. In the regard, one way to narrow the field is by selecting mutual funds on the basis of your individual financial goals. Some of the decisions that will help you finalise your financial goals include knowing if you are looking for long-term capital gains or a source of current income (short-term gains). This decision can be further broken down in a simple term by acknowledging your financial necessities. It could be something in the short-term like paying college fees when your child is in school or long-term like planning for your retirement.
At the stage, you also need to answer a few questions to decide what is the level of risk that you are willing to take while pursuing the financial goals. You need to ascertain if you are comfortable having a portfolio that will experience extreme ups and downs or if you would like a portfolio strategy that is more conservative in nature.
In the final stage of the analysis, you need to fix a time frame that you will be comfortable investing in the mutual funds that you select. This decision should be based on your future financial requirements. i.e., if you need the funds to be in liquid form in the near future or if you are comfortable with keeping this money untouched for years.
- The Expense Ratio – A Critical Factor
The expense ratio is a critical factor in mutual funds and have the potential to make or break any portfolio. The expense ratio is the percentage of assets that are dedicated to the management of advisory fee and expenses of operation. This is the amount that your mutual fund has to earn to break even prior to growing your money. Therefore, it is advised by many experts to select mutual funds which have the lowest possible expense ratio. Although the expense ratios may seem to have a negligible impact on the return when looked from an individual mutual fund perspective, it tends to have a big impact when these negligible amounts add up in your overall portfolio. Therefore, it is essential to consider the expense ratio when choosing a mutual fund for your portfolio.
- The Effect of Turnover Ratio
Turnover ratio can be defined as the percentage of a given portfolio that is purchased and sold every year. It is essential that you take this into consideration is for tax purposes. If you are not careful, then the taxes can take a big chunk of the returns from your mutual funds. Especially if the investor falls in the high-income group tax bracket. As an investor, you should be careful of those mutual funds which regularly turnover 50% or more of its portfolio. This, however, is not an issue if you solely use a tax-free account.
- Management Team
There is no shortage of management teams in the market. However, it is not wise to employ a mutual fund management team without proper research. The impacts of holding a mutual fund with a management team which has a history of losses or average performance over a period in which the stock market has performed well could be detrimental. When finding a management team, you should look for a firm which is built around one or more investment analysts or portfolio managers. Such a company should not ideally have a history of frequent internal upheavals. This is because such upheavals can have an impact on your funds. You should also check to see if these managers have themselves made investments alongside the fundholders.
Apart from the above mentioned tips, there are also other factors that need to be analysed when selecting mutual funds for your portfolio. Some of the key factors worth mentioning here include considering rupee-cost averaging, ascertaining benchmark for mutual funds, purchasing no-loan mutual funds, finding an investment philosophy that suits you, and methodical diversification of assets. Additionally, it is also imperative that you use the best and the most reliable resources when selecting mutual funds for your portfolio. This is because using resources which provide incorrect information may leave the entire process faulty, thus leading to financial loss, as well as loss of time and energy. Click here to find an example of a good resource in action.