Friday, May 25, 2012

5 Things To Check Before Selecting A Mutual Fund Scheme

With the emergence of different types of mutual funds, investors feel difficult to select the right mutual fund scheme, that is, the one that suits their needs best. There are many mutual fund beginners who started investing without having proper knowledge. These people consider investing just by seeing newspapers and magazine ads that present the stellar performance of the mutual funds that did well in the past. This is, however, not the right way of investing.

Let us now, discuss the important parameters that you should check before selecting a mutual fund scheme.

1. Past performance of the scheme
As with any other investment, past performance cannot guarantee its future success. But still you need to check the stability of the scheme. Look at the consistency in the track record of three years, five years or seven years. It does not matter, if they were the best schemes this year or last year. You just need to look if they performed good every year, well above the benchmarks and overtime as a consistent performer.

2. Fund manager ability
Before entrusting your money to a fund manager, you need to check his past experience in the market along with other credentials. Ask question on these and get answers.

Is the management good (its past performance, rational decision etc.)?
Check whether fund manager makes disciplined investment decision?
Does he have the ability to spot opportunities?
Check whether he works in investor's interest?
For how many years has he been working in the fund house?

Lets consider the above last question. When you find a good mutual fund with an excellent track record of more than 7-8 years, you need to know whether the fund manager you are talking to is the one who is actually responsible for these great returns, or a newly appointed manager.

3. Investment objective
The investment objective of the fund must coincide with your objective. It should suit your time horizon. The objective can be defined in terms of tax planning, high returns, capital appreciation in the long-run.

Example: Equity funds are more tax-efficient compared to debt funds. Also, close-ended equity funds focus on long-term capital-appreciation while short-term debt funds focus on regular income. You should look at the type, nature and option of the mutual fund scheme. You must choose a fund according to your risk-tolerance.

If you are high-risk investor, you can consider investing in equity funds (diversified and specialised) offshore funds and also mid-cap funds.
If you are a low-risk investor, you can consider debt funds, which invest money in government securities.
If you are a moderate-risk investor, you can consider index funds, balanced funds and asset allocation funds.

Along with your risk-tolerance you should also consider the style and portfolio of the scheme such as small cap, mid cap and large cap.

4. Age and size of the fund
Before, investing in a fund, know how long the fund has been operating. Sometimes, newly introduced funds have excellent short-term performance records. This is because, these funds have invested most part in only a small number of stocks.

These small number of stocks if performed well, gain success and can have a large impact on the performance of funds. But as these funds grow larger and larger by increasing the number of stocks they own, each stock will have less impact on the fund's performance. Then it becomes difficult to sustain the initial results.

Thus, make sure that the size and the age of the fund should be neither too large nor too small.

5. Seek low expense ratio and taxes
Expense ratio is the amount of expenses charged by the mutual fund company to operate your fund. It includes operating expenses for running the fund, marketing and selling expenses, audit fees, custodian fees, etc.

Therefore, choose a company that has low-cost fund expenses. It should be compared with the other similar funds. Even if you go for a high-cost fund, it must perform better than a low-cost fund to generate the same returns for you. A small difference in fees can bring a large difference in returns over-time.

High expense ratio have more impact on long-term investors, due to the effect of compounding. Also, be on the look out for better tax saving options.

Do not opt for mutual funds for short-term future needs, because, mutual funds are the best investment product for long-term investment. Therefore, decide the time horizon (minimum 3-5 years) before you go for mutual funds. Also, before starting your selection process, follow these factors and do your own research about the mutual fund, you wish to choose.

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