Mutual Funds are where the funds from numerous investors are pooled into one scheme. The fund manager then uses those funds to invest in an asset class to achieve its investment objectives.Mutual funds are classified into seven types based on their investment objectives: equity funds, debt funds, liquid funds, tax saving funds (ELSS), balanced funds, exchange-traded funds, and gilt funds.
Although as an investor, you should remember that not every scheme or portfolio of schemes is right for you. You should consider your investment objective, risk tolerance, and other factors before choosing mutual funds. However, making this choice can occasionally be challenging. So, here are a few rules to help you choose the right mutual fund:
- Define your Risk Appetite: Your risk appetite refers to how much risk you are willing to take with your investments. Some people have a higher risk appetite, so they can afford to invest in equity assets. For instance, equity mutual funds are riskier, and the portfolio may experience frequent ups and downs. However, these funds also frequently offer higher returns, making them a good choice for investors with a high-risk-high-reward attitude. Debt mutual funds, on the other hand, have lower risks and are more secure.
Butthey offer comparatively lower returns than equity funds, making them a good choice for beginners and conservative investors.
- Avoid Multiple Funds of the Same Category: You should not choose more than two funds from the same category. Investing in too many schemes within the same category, regardless of their performance, will not help diversify investment portfolios or maximise returns. There are high chances of overlap in the portfolios of these funds, so you would mainly be replicating your investments.
- Track Fund’s Performance: When evaluating the performance of funds in a specific category, look for funds that have performed consistently well over the long term. For example, ELSS has a three-year lock-in period, but holding a fund for at least five years is recommended because making short-term equity investments could be risky. For example, NFOs of established fund houses with a good performance history are generally safer than those of newly established funds.
- Track Fund Manager’s Performance: A good fund manager can transform the worst-performing mutual fund into the best-performing one. The fund manager has a significant impact on how your mutual fund performs because they are the person in charge of deciding which stocks or securities to invest in and how to allocate the funds for a particular mutual fund.
Therefore, if the fund manager is good, the fund will perform well. Whereas, if the fund manager is inefficient, the fund may not perform well in the future.
It may seem overwhelming to choose a mutual fund but researching and knowing your objectives will simplify the process. The more due diligence you conduct before choosing a fund, the better your chances of success.