How to Select Mutual Fund Schemes in India 2023: Benefits and Risks
A mutual fund is an investment option that collects money from different investors and invests in stocks, bonds, gold, and other assets. Now, while understanding the concept of mutual funds might be simple enough, selecting one requires learning about several related aspects. For example, factors like tracking errors, expense ratio, investment tenure, exit load, etc. influence the returns from mutual funds..
How to Select a Mutual Fund
To select a mutual fund, investors should primarily consider two points –
1. Financial Goal
Individuals mostly make investments with certain financial goals in consideration. A mutual fund is no different. Potential investors must take a note of their short or long-term financial goals, before choosing a mutual fund that can help them achieve the same.
2. Market Trends
Mutual fund selection can be based on market trends as well. In this case, an investor may not have any particular objective to fulfil and consequently look for plans that offer the best possible returns.
6 Factors to Consider While Searching for a Mutual Fund
1. Tracking Error
Tracking error is an indicator of the performance of a fund compared to the benchmark it follows. To simplify it, tracking errors represents the difference between returns generated by a mutual fund and the particular index it is following.
A point to note here is that tracking error is primarily associated with index mutual funds, as their returns are associated with a market index such as Sensex or Nifty 50.
Example:
The Nifty 50 has grown by 1.5% in a month. At the same time, an index fund associated with it has replicated a growth of 1%. Therefore, this 0.5% gap is the tracking error here. Usually, asset management companies (AMCs) present such differences in their annual fund fact sheet.
2. Expense Ratio
The expense ratio refers to the fee charged by AMCs to manage fund portfolios. Usually, this fee is applicable on a yearly basis and includes operating costs, administrative expenses, the fund manager’s salary, etc. The expense ratio is deducted from a fund’s final returns. Therefore, it affects an investor’s take-home amount.
Example:
Let’s assume a mutual fund has generated an annual return of 10%, and owing to its 0.5% expense ratio, the final returns from that fund will be 9.5%.
Therefore, opting for a mutual fund with a low expense ratio will incur a lesser fee. In this regard, one can choose Navi Nifty 50 Index Fund with an expense ratio of 0.06%.
3. Fund Manager’s Experience
The experience of a fund manager is another crucial point to evaluate while considering how to select mutual funds. Experienced fund managers are well-versed with the ups and downs of the market and know the best way to generate profits.
Moreover, they are also aware of various funds and how they have performed over the years. Hence, they can select various stocks, securities, and funds that will be perfect to meet an investor’s financial objectives.
4. Exit Load
Exit load in a mutual fund refers to the fee charged by an AMC to exit a scheme partially or fully within a certain period. The particulars about this fee are specified in the scheme related documents.
Factor in the exit load in the total returns from the mutual fund and choose one accordingly.
5. Investment Tenure
Investment tenure refers to the period for which one plans to invest in a mutual fund. Usually, this decision is customer-specific as it varies depending on their investment objectives.
6. Methods of Investment
There are two ways to invest in mutual funds:
a. Systematic Investment Plan (SIP)
This method allows individuals to route their investments into a mutual fund scheme through periodic payments. There are options to make monthly, quarterly, half-yearly, or annual investments into mutual funds. Individuals can start investing with as little as Rs. 500 per month.
b. Lump-Sum
As the name suggests, the lump-sum method allows individuals to invest all the amount at once.
Besides these pointers mentioned above, investors should constantly evaluate their risk appetite before going ahead with it. It means they should review their risk-taking capacity and progress accordingly to generate the best possible returns.
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Types of Funds That a Portfolio Should Contain
If you are wondering which mutual fund is best to invest in India, you have landed on the correct page.
Following are some types of mutual funds that can be included in a comprehensive portfolio –
1. Index Funds
Index funds curate an investment portfolio that follows a benchmark index. Securities included in this portfolio and their performance replicate the index that they follow.
2. Equity Funds
Here, the majority of a mutual fund’s proceedings are invested in a company’s equity or equity-related investment options. With this mutual fund type, the returns are high, but the risks are also substantial. These are ideal for individuals with a high-risk appetite and a longer investment horizon. There are various sub-types of equity funds based on the market capitalization of a company they invest in.
3. Debt Funds
Debt funds mainly invest in government and corporate bonds and/or securities. Compared to an equity fund, a debt fund has lower associated risk and return. These funds aim at capital preservation and are categorized based on their investment period.
4. Hybrid Funds
Hybrid funds are a unique type of mutual fund. These invest in both equity and debt funds and depending on that; they have several sub-types such as balanced, aggressive, multi-asset, arbitrage, etc.
Balancing portfolios comprising these funds mentioned above can protect an investor’s interest during different market scenarios.
Benefits of Mutual Funds
- Liquidity: Liquidity is one of the vital benefits of mutual fund investment. Investors have the freedom to withdraw their investment at any point they want. However, be mindful of the exit load before taking a decision.
- Diversification: Since mutual funds consist of multiple stocks and securities, the effects of market fluctuations get evened out over time. Thus, it safeguards the financial interest of investors; even if a particular stock or security does not perform well.
- Managed by Professionals: Investing in the stock market can be tricky for novice investors. However, one does not run that risk with mutual funds. Here expert portfolio managers are in charge of handling these funds. Thus, entry and exit from a fund are well-timed and serve the purpose of investors.
- Affordable: With mutual funds, especially the SIP scheme, investors can make small investments at regular intervals. Also, one does not need a Demat account for this purpose, which further increases their accessibility.
Risks of Investing In a Mutual Fund
1. Market Risk
Since mutual funds are directly related to the market, they involve undertaking a certain degree of market risk. There are several factors such as a business strategy, political and economic stability, etc., that can affect the market. These consequently reflect on the returns of a mutual fund.
2. Credit Risk
Credit risk occurs when an issuer of a mutual fund cannot deliver the results promised and defaults in interest or principal repayment. Debt mutual funds suffer from this, as fund managers here only invest in low-grade securities. Low-quality security funds usually carry a higher credit risk, which is why most conservative investors prefer investing in high-rated debt securities.
3. Interest Risk
Interest risk in mutual funds comes from the varying rates due to market conditions and demand for credit. Now, interest risk is inversely related to a mutual fund’s returns. It means increases in interest rate mean a price reduction of securities.
For instance, you invest Rs. 100 in a mutual fund at 5% for a specific number of years. If the market rate of interest goes up to 6%, chances are high that you will not get the expected returns, as it will reduce the selling price of your mutual fund units. In such cases, you need to wait for the interest rate to come down and then opt to sell.
4. Inflation Risk
Inflation increases in an economy when individuals lose their purchasing power. Investors are exposed to it when the rate of return fails to stay in line with the rising inflation rate.
Final Word
As most advertisements mention, ‘mutual fund investments are subjected to market risk’, it is imperative to understand the basics and learn how to select mutual funds. Doing so allows investors to make the right call.
Navigate to Navi Mutual Fund to set out on your investment journey today!
FAQs
Ans: Some of the benchmark indices that index funds track are Sensex, Nifty 50, etc.
Ans: Direct plans are where investors can apply and invest directly. There are no intermediaries in the purchase of the funds. It keeps the overall cost of investing low, as the investors need not pay any commission.
Ans: Regular plans represent mutual funds that are not available directly to investors. Here they need to go through an AMC or a broker to purchase units. Resultantly, investors need to pay commission, which increases the overall cost of borrowing
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
