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If you have made a decision to include mutual funds in your investment strategy but don’t know how to get started, it’s actually pretty easy with just a bit of due diligence on your part. You can get halfway there just by understanding your own tolerance for risk and getting clear on your investment objectives. Picking winning mutual funds involves choosing those that provide good returns at a low cost, but funds are even bigger “winners” when they strategically enhance your own portfolio and investing objectives.
Once you’re ready to choose some mutual funds, there are ways to analyze them such as looking at each fund’s past performance history, management team, and expense ratios.
The following are the factors to be considered to pick up the best Mutual Funds
Before investing in any fund, you must first identify your goals for the money being invested. Identifying a goal is an important step in whittling down the universe of more than 8,000 mutual funds available to investors. In addition, you must also consider personal risk tolerance.Risk and return are directly proportional and you must balance your desire for returns against your ability to tolerate risk.
The expense ratio (ER), measures how much of a fund’s assets are used for administrative and other operating expenses. An expense ratio is determined by dividing a fund’s operating expenses by the average dollar value of its assets under management (AUM). Operating expenses reduce the fund’s assets, thereby reducing the return to investors.
All else being equal, you want to own funds that have the lowest possible expense ratio. If two funds have expense ratios of 0.50 percent and 1.5 percent, respectively, the latter has a much bigger hurdle to beat before money starts flowing into your pocketbook. Over time, these seemingly paltry percentages can result in a huge difference in how your wealth grows.
Mutual fund companies make money by charging fees to the investor. It is important to understand the different types of fees associated with an investment before you make a purchase.
Some funds charge a sales fee known as a load, which will either be charged at the time of purchase or upon the sale of the investment. A front-end load fee is paid out of the initial investment, when you buy shares in the fund, while a back-end load fee is charged when you sell your shares in the fund.
Front-end loaded shares are identified as Class A shares, while back-ended loaded shares are called Class B shares.
Both front- and back-end loaded funds typically charge 3% to 6% of the total amount invested or distributed, but this figure can be as much as 8.5% by law.
Time horizon refers to the time period for which you wish to keep your money invested in a mutual fund. It can be either as short as 1 day to as long as more than 5 years. Different fund categories work best for different time horizons. This is because some funds invest in shorter dated debt and others invest in longer dated debt. Equity funds should only be chosen if your horizon is more than 5 years. The market can be highly volatile in the short term but tends to move higher with earnings growth, over time.
Risk and return ratios like standard deviation, Sharpe ratio etc measure Mutual Fund risk and returns. Along with those ratios, one also should check out the ALPHA of the fund. Alpha tells us what extra or less the fund manager has generated out of a given portfolio in comparison to benchmark.
In other words alpha is the performance ranking of the fund manager. You may check how often the fund manager has generated positive alpha in last few quarters and also keep a watch on its consistency going forward.
The confidence of the investor in any particular mutual fund scheme is substantiated and further solidified through assessment of the net asset of a mutual fund scheme. This confidence grows over time and helps in choosing the right schemes that have seen a good market performance and stay ahead of other schemes in the growth cycle. The flagship mutual fund schemes with high asset under management are generally managed by the best and experienced fund managers.
Fund manager plays a very important role in the fund’s performance. Though it is a process oriented approach but still fund manager is the ultimate decision maker and his experience and view point counts a lot. You should know who the fund manager of the scheme is and what his past track record is.
You should also look at the performance of other funds which he is managing. If the fund manager of the scheme has recently been changed, don’t panic. Just keep a watch on his performance by looking at alpha and quarter to quarter performance.
If you find that due to change in the fund manager there is considerable effect on the fund’s performance which does not suit your risk appetite then you may make a decision to exit.
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