What is the volatility of the fund? Remember in most instances funds with high returns tend to be more volatile. E.g. funds with mid-cap exposure and sector funds tend to be more volatile, but also offer higher returns. Also some fund managers tend to churn the portfolio in order to give higher returns, thus making it very volatile.
Do you know what is the most essential factor considered by investors when choosing the Mutual funds for investment? Yes it is returns. This despite the warning issued by the fund houses that past returns do not guarantee future performance. As a result, many people focus only on the returns while investing and so end up choosing wrong funds. Subsequently, they end up losing their hard earned money. So why is the focus on returns wrong?
WHAT ARE RETURNS?
Returns are nothing but the appreciation in the NAV of the fund. Usually, they are expressed as CAGR (Compounded Annual Growth Return). It is calculated over a time periods exceeding one year and assumes the growth occurs at a constant rate. So what happens is it evens out the ups and downs in the movement of the NAV of the fund. E.g. if you have invested Rs. 10,000 on 1st Jan 2007, which becomes 30,000 on 1st Jan 2009, you get a CAGR of 73.21%.
However what happens is that this CAGR tends to mask those periods when the fund was a dud. Remember all the funds go through ups and downs, and higher the fund rises, sharper will be its downfall. During the bull run, all the funds show upward trend. Also if the fund is a sector fund, it will perform well only during the period when the sector is in demand. When the sector starts languishing, its CAGR will go down. Look at infotech sector as example.
EVALUATE OTHER FACTORS TOO!
Despite this, greed rules the investors’ mindset. They want to get the maximum possible returns. This mindset is very well capitalized by the mutual fund advisors, who concentrate solely the returns generated by the fund. They promote the fund clocking the highest return, completely ignoring the other factors that should be considered when choosing the mutual fund. Hence it is essential to be wary of such advisors.
OTHER FACTORS SURROUNDING THE MUTUAL FUND
So what are the other factors that must be considered when selecting a mutual fund? Besides the returns following are the other factors that must be considered when choosing the fund for investment.
- What is the volatility of the fund? Remember in most instances funds with high returns tend to be more volatile. E.g. funds with mid-cap exposure and sector funds tend to be more volatile, but also offer higher returns. Also some fund managers tend to churn the portfolio in order to give higher returns, thus making it very volatile.
- What are the fund management expenses? Higher the expenses, lower the returns.
- Check the performance of the fund vis-à-vis its competitors and the benchmark index.
- Is the fund appropriate for your goal? E.g. if you are saving for a short-term goal like going on a holiday, you are better off investing in debt funds instead of equities, which tend to very volatile over a short-term. Don’t simply look at the returns when deciding the choice of fund.
- Are you in for the long haul? If so, equities should form the core of your portfolio, as time in the market is more important than timing the market.
These are some of the most important factors that must be considered when investing in mutual funds.