Once you have put your foot down and decided to start investing, it is important that you carefully evaluate the funds you want to invest your funds into. Assessing their past performance is a crucial factor but not the only factor that you as a prudent investor need to look into. In an era where people lack the time to thoroughly analyze funds before placing investments; past returns seem like the only available criterion to fix your belief in an investment. Often, distributors show prospective clients the performance of a fund over previous years, but not in comparison with its peers. Returns also do not offer investors a clear picture on the investment style of fund managers. Pitches are also made on the basis of commission payable to the agent rather than the past returns of the fund. The reason why most investors fail miserably to make the right choice of funds is the disparity in performance of funds over different time frames. For instance, a fund may have performed exceedingly well over a time frame of 3 years, but it may have eroded investors off their profits over a time frame of 5 years. The main reasons behind this disparity can be attributed to factors like wrong cash calls and concentrated bets. Also, mid-cap funds and small-cap funds tend to have less liquidity than large-cap funds and subsequently, when they are under the pressure of redemption, they tend to come under fire and sell their shares at sale prices. The investment mandate of a fund may also be the reason behind the disparity of performance in funds over different time periods as some funds, that follow high-gain and high-risk strategies create disparate or inconsistent returns as compared to funds with a balanced mandate. Opting for debts like loans or a personal loan etc to finance your propositions may be the only last resort. Having EMIs with exorbitant interest rates will only make your financial future a little weak.
Inconsistencies in the performance of a fund can be overlooked if a fund has performed better than its peers over a time frame of 7-10 years. If this is not the case, then steer away from such funds. The consideration of past returns while selecting a fund will be handy only when it has been effectively combined by several other factors like the expense ratio of the fund, its sectoral and security compensation, and its turnover rate. The lower these rates, the more viable will be your fund. Take into consideration qualitative factors of the fund like such as the reputation of the fund house, its fund manager, and the profile of the fund. Financial advisors use risk-adjusted returns or alpha to evaluate a fund, as it is a derivative of the past performance of the fund. It is a reflection of several funds such as the expertise of the fund manager, the extra risk incurred by the fund, rather than its sole performance in isolation.
Funds come with both aggressive as well as defensive portfolios, and an investor must choose a fund keeping in mind his appetite for risk and the time horizon of investments before choosing a fund. Any instance of change in fund manager or merger of funds, and other similar activities must also be taken into consideration by an investor before placing his investments in a fund.