With the benchmark Nifty 50 and Sensex Indices touching new highs every week, mutual fund investors have reaped great returns this year from the buoyant Indian stock market. Mutual funds allow common people to take advantage of the research and guidance of experienced financial analysts and management teams who aim to generate returns higher than the index. However, it is not without reason that we have the disclaimer “mutual funds are subject to market risks, read all scheme related documents carefully” accompanying all mutual funds ads.
Before investing in a mutual fund, one must thoroughly understand the concept of mutual funds and the types of mutual funds offered:
What are mutual funds?
Mutual funds are funds that gather money from numerous investors to invest in different financial instruments such as equity, debt, bonds and other assets. They are actively managed funds operated by professional money managers who generate return by investing according to the desired risk level of the portfolio.
Types of mutual funds
There are several types of mutual funds offered by investment firms:
The largest category of mutual funds, equity funds invest in the listed shares of public companies. Fund managers follow different styles of investing according to the fund’s theme, such as investing in high-growth companies for high long-term returns, investing in high dividend yield companies for a good cash flow, following diversification or investing in sector-specific companies etc.
A popular alternative, index mutual funds aim to replicate the returns of the index it is based on, such as a Nifty 50 index fund. They have lower fees as they are passively managed funds and don’t require a fund management team, but can’t generate returns higher than the index. They differ from exchange-traded funds (ETFs), as they can’t be traded on the stock exchange throughout the day.
Fixed income funds/debt funds
These funds aim to generate a fixed income for their investors, and they invest in government and corporate bonds, securities and debentures. They are less riskier than equity funds and provide stable income, but are prone to credit risk.
Money market funds
Money market funds invest in highly liquid short term debt instruments, and generate low returns with minimal risk. They are beneficial for investors who want to invest funds for the short-term and wish to earn slightly higher returns than their savings account.
Balanced funds have a mix of both debt and equity in their portfolio, and aim to provide more stable returns with relatively lower risk. The ratio of debt-to-equity may be fixed for the fund’s entire duration, or be dynamically adjusted by a fund manager to generate better returns.
Gilt mutual funds only invest in government securities, making them very low risk. While there is no credit risk as the government doesn’t default, their returns reduce with an increase in interest rates.
Now, choosing the right mutual fund can be a very difficult task, as there is a plethora of options available, designed for various different types of investors. Before investing in a mutual fund, one must consider several factors to help them decide the appropriate fund for them. But what are those factors?
Here is our list of tips to help you to find best performing mutual funds in India 2021:
Your risk tolerance and goals
One of the most important factors to help you pick a mutual fund is finding out your risk tolerance and listing your goals. Are you investing for a short-term purchase, or for a long-term retirement? How comfortable are you with having a portfolio that can lose and gain more than 50% of its value? Generally, equity funds are recommended when investing for long-term goals, as it can give the highest returns in the long-term. However, debt funds provide a constant cash flow, and are suitable for low-risk appetite individuals and for retirees who require a steady income for their expenses. Balanced funds provide both fixed and variable income, and help reduce the overall risk of the portfolio, which makes them suitable for investors who can take moderate risk.
Your investment philosophy
Do you believe in investing in growth companies that aim to grow 10 times their size in the future? Or would you prefer investing in value stocks that are trading at a discount to their fundamentals? Do you prefer sticking with bluechip companies and debt securities, or are willing to invest in lesser-known firms? To pick a mutual fund that is appropriate for you, you must find your investment philosophy and look for mutual funds centered around it, as it will help match your risk tolerance and needs with the suitable mutual funds.
Diversification of the portfolio is definitely an important aspect to look at in mutual funds. Some equity funds are sector-specific, which are extremely high risk as impact on that sector can impact the entire portfolio significantly. Diversified portfolios have investments in multiple sectors, which prevent the impact of one sector from affecting the entire portfolio significantly. Some mutual funds also offer global equity funds, which allow for further diversification as the economy of the home country may not move in tandem with the economies of other countries the fund has invested in.
A mutual fund’s expense ratio refers to the percentage of the fund’s assets used for administrative expenses, such as salaries of the fund managers, taxation, legal expenses etc. Funds with a high expense ratio reduce your overall returns, and hence must be avoided unless they generate much higher real returns after accounting for their expenses. ETFs and index funds have the lowest expense ratios in the industry, as they are passively managed funds, but can only generate returns equal to the index.
Experience of the Management Team
A mutual fund that has an experienced, well-performing management team has much more chances of succeeding than a mutual fund with a management team that has no experience or has consistently generated lower returns than the benchmark. Every mutual fund provides details of its management team, and some thorough research can help avoid mutual funds that don’t provide the optimal returns.
Although past performance is not a guarantee of future returns, it can still give the investor some idea of the mutual fund’s performance. Funds that have been performing well for a long time with the same management team provide a testament to the abilities of the fund managers. On the other hand, investing in new mutual funds could prove to be riskier, as there is no track record and evidence to show whether the fund has the potential to outperform the market or not.
Follow a system investment plan (SIP)
Following a SIP can not allow you to develop a disciplined habit of saving and investing, but also help lower your average cost of acquisition. By investing a fixed sum irrespective of the share price, you will be able to buy more shares when the price is low, and lesser shares when the price is high, leading to a lower total cost than buying a lump sum amount at a high price.
Compare with other investment options
Lastly, before investing in mutual funds, one must compare its returns with other investment options to decide how much of your capital you should allocate to mutual funds. Passively managed index funds and ETFs are a great option for long-term investors, as it is difficult for most fund managers to beat the index every year in the long term. Fixed deposits and gold also remain popular options for risk-averse investors. Lastly, one can also invest in equities by themselves, if they have enough capital and knowledge and don’t wish to depend on fund managers. However, it is often difficult for investors to decide what factors to consider when choosing a company to invest in for the long-term. To help you get started, we provide you with a list of questions that will help you regarding how to choose the right stock in India.
To conclude, this is our list of factors that will help you choose the right mutual fund in India. You must consider your risk tolerance, long-term and short-term goals, investment philosophy, experience of the management team, and compare the mutual fund’s return with other investment options to help you choose the right mutual fund that suits your needs.
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