It is important to compare the performance of the fund with the funds having the same profile. E.g. a small-cap fund must be compared against another small-cap fund. Don’t compare it with a banking fund, as both the funds have different profiles. Also compare the performance of the fund vis-à-vis its benchmark index.
Swati had just started working. Her employer conducted seminars highlighting the importance of investing. As a result, Swati got interested in investing. She asked her friend, who recommended she invest in an infrastructure fund. Accordingly Swati went ahead and invested. But in the recent market crash, she found her investment had lost more than 70% of its value.
There are many people like Swati, who choose wrong funds and end up losing their money. Part of the problem is because we tend to follow the investments chosen by our friends and relatives. In the process, what we forget is that each of us is unique, with distinct risk profile and goals. So what is right for one may not be right for another. Another part of the problem is that most mutual fund advisors tend to sell the fund offering them the highest commission instead of the one appropriate for their clients.
Also with the wide array of the mutual funds available in the market, buyers get very confused. They are taken in by the jazzy advertisements issued by the various fund houses. So they end up selecting the wrong fund and thus lose their hard earned money. So if you are looking to get the best possible returns, it is important to choose the right for you, based on your risk profile and your investment objective. Here are the most important factors that you must consider when choosing the fund.
- Performance: It is important to compare the performance of the fund with the funds having the same profile. E.g. a small-cap fund must be compared against another small-cap fund. Don’t compare it with a banking fund, as both the funds have different profiles. Also compare the performance of the fund vis-à-vis its benchmark index. E.g. if the fund uses BSE Sensex as its benchmark, find out how the fund fared against Sensex.
- Risk: No investing is risk-free. If you are looking for any type of good returns, you should have the capacity to bear the associated risk. Higher the risk, higher the returns. Having said that, certain funds are riskier than others. E.g. mid and small cap funds as well as sector funds are riskier than large cap funds. The risk can be said to be worth it, if it can give the returns that can justify the risk. However when the going gets tough, these funds tend to show a sharp decline in their value. So unless you are not able to withstand this type of volatility, stay away from these funds.
- Portfolio: How the fund performs as well as the risk it takes will depend on its underlying portfolio. If the fund has large exposure to trading stocks or stocks falling in non-A group, then the fund is very volatile and carries higher risks. Similarly the fund having large exposure to mid and small cap stocks will give outstanding returns during the bull run but will lose sharply during the bear run.
- Management: Does the fund have a star fund manager or is there a fund management team? If the fund is new, what was the experience of the fund house in managing other existing funds? If the fund manager is new, what was his track record in his previous funds? Remember that when you are investing in the fund, you are actually putting your faith in the management expertise of the fund manager or fund management team.
- Expenses: Expenses of the fund are the often overlooked aspect. Remember, fund expenses erode the NAV of the fund. Higher the expenses, lower the NAV. You as an investor, are bearing these expenses. Over a period of time, these expenses add up and significantly reduce your returns. In fact, new funds have significantly higher costs than the old funds. Also international funds and fund of funds are costlier than normal diversified funds.
You as an investor should exercise extreme caution when selecting the mutual fund for investment. Select the fund based on its performance, risk, expenses, portfolio and management expertise. It is important for you to carry out your research thoroughly as choosing the wrong fund can lead to big financial losses for you in the long run.