How to Pick a Mutual Fund with Better Returns?

A Mutual Fund scheme is a type of investment instrument where your money is invested as per the broad objective of the scheme. The funds collected from various investors like you and invest in securities like equity shares, bonds, and certificates of deposits. There are many different types of Mutual Funds available. These investments may be made for the short term, medium term, or long term duration. The kind of assets invested determines the risk factors of the funds. For some investors, this vast universe of available products may seem overwhelming. However, picking a suitable Mutual Fund might be easier than you think. How? We will discuss.

Introduction: 

Before investing money in any fund, you must first identify our goals and aims for the Mutual Fund investments. The objective can be short term or long term. The financial aspiration of the investor can be to pay for children's higher education or buy a house or a retirement fund. Identifying a Mutual Fund is a two-step process- the first selection of the Mutual Fund category and the second selection of a scheme in that category. It would help if you also considered personal risk tolerance. Can you accept dramatic swings in the portfolio value of your investment, or you are a more conservative investor? Risk and return are considered directly proportional.

Factors for selecting Mutual Funds category:

i. Investment Objective:

This factor determines your financial goals, which you should accomplish with the Mutual Fund investment. Your investment objective may be short or long-term.

ii. Time Horizon:

Time horizon means the period you wish to keep your money invested in a Mutual Fund Scheme. It can be as short as a day or as long as more than five years. For different time horizons, different fund categories work the best. Since some funds invest in shorter-duration debts, and some invest in longer-term debts. If you need money in the short term, you may want to invest in debt funds which invest in treasury bills of the Government, commercial papers or bonds issued by corporates or the Government.  Equity funds should ideally be chosen if you have an investment time horizon for more than five years period in mind. Funds that invest your money for the duration of 1 day- 3 months are called Liquid Funds, those invested for the period of 3 months- 1 year are called Ultra Short-duration funds, one year-3 year are called Short-duration funds.

iii. Risk tolerance:

Risk tolerance means the amount of risk you as an investor are willing to take with your invested funds. All fund houses are required by the securities market regulator SEBI (Securities and Exchange Board of India) to display a riskometer made mandatory in 2015. There is 5 level of risk associated with the invested funds. These levels are – low, moderately low, moderate, relatively high, and high. 

Factors for choosing the best Mutual Fund Scheme:

After selection of the Mutual Fund category, now you  need  to choose a Mutual Fund Scheme to your needs within that category based on the following factors:

i. Performance v/s Benchmark

To assess the performance of the Mutual Fund Scheme, you may compare it to the benchmark index. The benchmark index is a guide to the investment policies of the scheme. SEBI has also mandated that the scheme use the Total Returns Index (TRI) variant of indices as their benchmark. TRIs were made on the assumption that dividends are reinvested in Mutual Funds as and when they are declared. This makes them a better benchmark than ordinary Price Indices (PI).

ii. Consistency of the performance

The Mutual Fund should provide consistent returns in both phases of the stock market. It should generate good returns for its investors consistently over the period of time.

iii. Performance v/s Category

An equally important factor in assessing a Mutual Fund Scheme is its performance compared to its active peer group. It gives a holistic understanding of the performance of the scheme. You should compare only the same type of Mutual Fund Scheme.

iv. Fund Manager's experience

Fund Manager's expertise is crucial in selecting the Mutual Fund. You should evaluate the performance of the fund at the helm.

v. AMC Track Record

AMC Track Record: An Asset Management Company (AMC) is also known as Fund House. It is the Company that manages a Mutual Fund Scheme. You should check the track record of an AMC while choosing a Mutual Fund Scheme.

vi. Expense Ratio

Generally, the expense ratio shows the net return of a Mutual Fund Scheme. The lower the expense ratio, the higher are the net returns of a Mutual Fund Scheme. The fees charged by AMC for the administration, management, promotion, and distribution of a Mutual Fund Scheme. The maximum that a mutual fund can charge from the investor is capped at 2.25% of the total funds' assets. Direct plans of Mutual Funds schemes have a lower expense ratio than regular plans as no distribution commission needs to be paid to the Mutual Fund distributors in the case of the Direct plan.