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Here are some things to keep in mind while choosing a fund:
History is important. Before investing, check the historic performance of the mutual fund scheme, the asset manager’s investment decisions, fund returns and so on. While the past performance is not an indicator of the future, it could help you figure out what to expect in the future. You can understand the investment philosophies of the fund and the kind of returns it is offering to investors over a period of time. It would also make sense to check out the two-year and one-year returns for consistency.
Statistics such as how the fund had performed in the bull and bear markets of the immediate past would help you understand the strength of a fund. Tracking the fund’s performance in the bear market is particularly important because the true test of a portfolio is often revealed in how little it falls during a bearish phase.
Match The Scheme’s Risk With Your Profile:
Even though a mutual fund diversifies its portfolio to reduce risk, they may eventually invest in a single type of asset. The risk of the fund varies with the kind of assets it is invested in. For this reason, check if the mutual fund fits your risk profile and investment horizon. For example, certain sector-specific schemes come with a high-risk, high-return tag. Such plans are suspect to crashes in case the industry or sector loses the market’s fancy. If the investor is risk-averse, he could instead opt for a debt scheme with little risk.
However, if you are a long-term investor, who doesn’t mind risk, you could go ahead with the sector-specific mutual fund scheme. For this reason, most investors prefer balanced schemes, which invest in a combination of equities and debts. They are less risky that pure equity or growth funds, which are likely to give greater returns, but more risky than pure debt plans.
While choosing a mutual fund, one should always consider factors like the extent of diversification that a mutual fund offers to your portfolio. A mutual fund can offer diversification either by investing in multiple assets, or by balancing your overall portfolio.
For example, suppose your portfolio contains 70% exposure to stocks from different industries, then it makes sense to invest the 30% in a debt fund to balance the portfolio. Similarly, if your portfolio has a lot of exposure to a particular sector like IT, then avoid investing in a mutual fund that also invests in IT. This way, you can balance your exposure to a similar kind of risk.
Know your Fund Manager:
The success of a fund, to a great extent, depends on the fund manager. Some of the most successful funds are run by the same managers. It would be sensible to always ask about the fund manager before investing as well as knowing about changes in the fund manager’s strategy or any other significant developments that an AMC may have undergone.
For instance, if the portfolio manager, who generated the fund’s successful performance, is no longer managing that particular fund, you may do well to wait and analyze the pros and cons of investing in that fund.
Read the Fine Print:
The prospectus says a lot about the fund. Reading the fund’s prospectus is a must to learn about its investment strategy and the risk that it is prone to. Funds with higher rates of return may carry a higher element of risk. Hence, it is of utmost importance that an investor always chooses a particular scheme after considering his financial goals and weighs them against the mutual fund’s risk.
That said; remember that all funds carry some level of risk. Just because a fund invests in government or corporate bonds does not mean that it does not have any risk.
A fund with high costs must perform better than a low-cost fund to generate returns for you. Even small differences in fees can translate into large differences in returns over a period of time.
So, ensure the costs and returns tally. There is no point in spending extra if it is delivering the same kind of returns like a low-cost fund.
Finally, an investor must not enter and exit mutual funds as and when the market turns. Market cycles are natural. Be patient. Like stocks, mutual funds also pay off only if you have the patience to wait. This applies for both buying and selling. Don’t pick a fund simply because it has shown a spurt in value in the current rally.
Ensure its returns are consistent. Similarly, don’t sell off a mutual fund just because it is not performing well due to poor market conditions. However, it makes little sense to hold on to a fund that lags behind the market year after year.