Mutual Fund Selection And Comparison Criteria: Learn FREE

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Most people make mutual fund buying decisions based on advise given by friends or based on the mutual fund ranking provided by different websites. Both the means are not the right way for selecting the mutual fund that would be the best for you. In fact mutual fund ranking has become a business now, many popular websites get paid by mutual fund companies for ranking their mutual fund above other funds.

When it comes to investment, we should not trust anyone else but our own research. Mutual fund selection is an art and anyone can learn this art. Once you complete reading this article you would have known all the basics of the art of mutual funds selection. In this article we will discuss the different factors that shall be considered for comparing different mutual funds and then selecting the mutual fund that would be best for you. So, lets begin.

Following are the major factors on basis of which mutual funds shall be compared:

1. Your risk profile

A risk profile is an evaluation of an individual’s willingness to take risks, considering the threats to which he is exposed. Broadly, mutual funds invest in either in equity or debt or both. Equity is considered riskier than debt because it has no guaranteed return and its market value is relatively more volatile whereas debt is considered less risky because it gives fixed return in the form of interest or coupon payment and it is relatively less volatile. A person’s risk profile can be categorized into following categories:

> Extremely Risk Averse
> Moderately Risk Averse
> Risk Neutral
> Moderately Risk Oriented
> Extremely Risk Oriented

A person whose is Extremely risk averse should buy a mutual fund where only 0-20% funds are invested in Equity and remaining are put in safer options like debt, gold etc. Whereas, a person who is Extremely risk oriented should buy mutual funds with 90-100% allocation towards equity. Similarly, ideal asset allocation differs for everyone based on their risk profile. InvestXP will soon launch a ‘Risk Profile Calculator’ on our website that will help you in assessing your risk profile on your own.  

2. Time horizon of investment

Time horizon of investment refers to the period for which investment is made. In other words, it is the period after which investment has to be withdrawn for meeting the goals like marriage expense, buying a car, buying a home, funding for education of children, retirement etc. Time horizon of investment can be as short as a few days and as long as 10 years or even more. For short period (less than a year) of investment liquid funds are more suitable which invest a major portion in Money Market. For a medium term (1-3 years) and long term (more than 3 years) a suitable fund shall be selected after considering your risk profile.

3. Expenses deduction and expense ratio of mutual funds

Mutual funds charge their fees in the form of deduction of operating expenses from the gross return earned. Depending on the type of fund, operating expenses vary widely. The largest component of operating expenses is the fee paid to a fund’s investment manager or advisor. Other costs include recordkeeping, custodial services, taxes, legal expenses, and accounting and auditing fees. Expenses that are charged by the fund as reflected in the fund’s daily net asset value (NAV) and do not appear as a distinct charge to shareholders. 

Expense ratio = Annual Operating Expense / Assets under management

The current average expense ratio for actively managed mutual funds is between 0.5% and 1.0% and typically goes no higher than 2.5%, although some fund ratios have gone as high as nearly 20%. Higher expense ratio does not always mean that the fund is not good. For example if Fund A has Gross Return of 10% and expense ratio of 1% but Fund B has Gross return of 15% and expense ratio of 2%, in such case even though the expense ratio of Fund B is more than Fund A but still Fund B is better because Fund A has net return of 9% (10%-1%) while Fund B has net return of 13% (15%-2%).

4. Size of Assets Under Management (AUM)

It is believed that the Mutual Funds that have very high AUM find it difficult to manage the funds. Due to excess funds they start holding more cash or make wrong stock selection in haste. So, one should prefer to invest in a fund that neither has very high nor very low amount of AUM. AUM size between INR 5000 cr to INR 25000 cr should be considered decent. However, different experts have have different views on this point.

5.  Consistency of returns

Never judge a mutual fund by its recent performance, in fact long term performance shall be the basis of fund selection. One should compare the mutual fund returns with market index returns of similar category for 2 years, 3 years, 5 years and 7 years. Here ‘Category’ means the composition of fund, whether it consists of Smallcap stocks, Midcap stocks or Largecap stocks. For example: If performance of a midcap based Mutual Fund has to be assessed then it shall be compared to Midcap Index returns only and not to Large Cap Index returns.

6.  Tax implication on maturity

This is a very important factor that is generally ignored by investors. Returns from equity oriented Mutual Fund (where asset allocation towards Equity is greater than or equal to 65%) are exempt from tax if held for more than one year, where as it is chargeable to tax at 15% if held for a shorter period. Whereas, funds other than equity oriented mutual funds are taxable at slab rate after indexation if held for more than 3 years and benefit of indexation is not allowed if held for a shorter period.

The investment decision shall be made after considering all the above points. Not even a single point shall be left out from your consideration. You may take help of an expert but it is important that at least you try to make your research yourself first and then consult an expert for reassurance.

If you do not where you can find all these statistics and data about mutual funds then read this article: Most Authentic Website For Mutual Fund Research

InvestXP will soon launch a ‘Risk Profile Calculator’ on our website that will help you in assessing your risk profile on your own. Follow us on social media for constant updates links are given on the right hand side at the top.

Author:

Sahil Goel | Linkedin  

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