I want to invest in mutual funds but don’t know which scheme will be suitable for me. What should one look for while choosing a mutual fund?
— Deepak Nag
Stability over volatility | ||
| Investment of RS 10,000 | Returns | |
| Fund A | Fund B | |
| Year 1 | 16% | 15% |
| Year 2 | 5% | 16% |
| Year 3 | 25% | 15% |
| Year 4 | 20% | 16% |
| Year 5 | 10% | 15% |
| Corpus at end of 5 years | Rs 20,097 | Rs 20,465 |
| After five years, the value of investment in Fund A is lower than that in Fund B despite the stellar returns from the former in the third and fourth years | ||
There are over 400 equity-based mutual funds on offer. The vast array of mutual fund schemes can be confusing for the lay investor. However, there are some thumb rules to help you zero in on the best schemes. The four parameters on which a fund should be evaluated are as follows:
PERFORMANCE
The returns from a fund are the simplest and most basic measure of its performance. Sure, the past performance of a mutual fund is not an indicator of future returns. But this is true with regards to absolute performance. In relative terms, a mutual fund that has done well over the long term is less likely to do badly in the future.
STABILITY
While returns are important, they are not the only thing one should look for while choosing a fund. A fund that consistently earns 15-16% annualised returns over 5-6 years is better than one that has a chequered performance, earning 20-25% in one year and 5% in the next. As the table below shows, Fund B has given higher returns than Fund A even though the latter gave very high returns for two years. Clearly, slow and stable growth is better than spectacular, but volatile, returns.
EXPENSES
How much your fund charges you in terms of entry and exit loads and the annual fund management charges is another crucial factor to keep in mind. Don’t dismiss the 2.5% expense ratio so easily. As the table above shows, a 1% difference in the expense ratio can mean a 20% difference in the corpus in 20 years.
INVESTING MANDATE
Expense Ratio matters | ||
| Investment OF RS 10,000 | Returns | |
| Fund A | Fund B | |
| Expense ratio | 2.5% | 1.5% |
| Corpus after 5 years | 15,386 | 16,105 |
| Corpus after 10 years | 23,673 | 25,937 |
| Corpus after 15 years | 36,425 | 41,772 |
| Corpus after 20 years | 56,044 | 67,275 |
| The calculation assumes that both funds earned a nominal annualised return of 11.5% before factoring in the expense ratio | ||
Choose a fund that suits your risk profile and investment objective. If you are averse to taking risks, opt for a fund that has a small equity exposure. If you can afford to take risks, go for an equity mutual fund. Here too, you need to choose between riskier sectoral, mid-cap and small-cap funds and the less risky index funds or diversified equity funds.
Also Read
• ‘Fundamentals’, a 26-part series on the basics of mutual fund investing.
• Find out the best performing funds in different categories in ‘Mutual Fund Monitor’.
• Read our mutual fund section .
• Go through our special issue on ‘Best Mutual Funds ’
