Selecting Mutual Funds Carelessly Can Cost You Dear
Aug 26, 2019

Author: Divya Grover

(Image source: Image by Tumisu from Pixabay)

Investing in equity and debt requires investors to have ample knowledge about market conditions. But lack of time and/or incomplete understanding of these securities may prevent investors from directly investing in them. Mutual funds are designed to make the investment process simpler for such investors by creating a professionally managed portfolio of diversified securities.

Over the years, there has been a rise in the number of fund houses as well as the schemes offered by each of them. This makes picking the right scheme/s for the portfolio an overwhelming experience.

Even if you are investing for the long-term, choosing the right scheme is very important. The scheme's past performance may impress you enough to invest in it. But what's more important is that the scheme sustains its performance in the future. After all, it's your hard-earned money that you are deploying to achieve your goals.

[Read: Want To Select The Top Mutual Funds For 2019?]

Many investors turn to distributors or independent financial advisors (IFAs) to seek help in selecting the right schemes. However, you cannot over rely on them or trust them blindly. There have been several instances of mis-selling and ill-advice because advisers, unfortunately, do not always have your best interest at heart.

It will also be imprudent to rely on the star-ratings assigned to the fund or the advice of your friends/relatives to select the schemes.

If you are struggling to select the right mutual fund here are the facets/parameters that you need to consider:

Evaluation of your needs

You will have to decide whether you are investing for long-term goals such as retirement, children's future, or short-term goals like buying a car, vacation abroad, etc. Without a specific goal, there will be no clear direction for your investment to grow.

After that, decide the level of risk you are willing to take. If you have long-term goals and can handle volatility in the short-term, you can follow an aggressive investment approach and invest in equity funds. On the other hand, if you are a conservative investor, you can park your savings in debt funds or a mix of equity and debt funds.

[Read: Are You Waiting For The Right Time To Invest In Equity Mutual Funds? Read This!]
Selection process

To select the right scheme based on your needs, you need to assess the schemes on various quantitative and qualitative parameters mentioned below:
1. Quantitative parameters
  
  A good mutual fund is one that consistently performs better than its benchmark and category peers across bull and bear phases. Evaluate the performance of the scheme across 1-year, 3-year, and 5-year rolling period to shortlist the scheme that has performed consistently well across periods. Make sure that you evaluate the performance with schemes within the same category.
  
  [Read: Why Some Mutual Funds Do Not Generate Consistent Returns]
  
  You should further check if the risks that a fund has undertaken are worth the returns you earn. Check if the fund generates a higher return for the same level of risk undertaken by other schemes using risk-reward ratios like Sharpe and Standard Deviation.
2. Qualitative parameters
  
  Qualitative parameters are often overlooked though they are a vital aspect in the selection process. It involves determining the quality of the portfolio and the efficiency of fund manager/house.
  
  The fund house should have a fairly long track record and must follow robust investment processes with adequate risk management systems in place.
  
  The fund's performance is dependent on the ability of its fund manager. Check the qualification and experience of the fund manager and the track record of the other schemes managed by him/her.
  
  [Read: Why Qualitative Aspects Are So Important To Pick Mutual Funds]
  
  In addition, the fund's portfolio must be well diversified across stocks/sectors. In case of debt funds, determine if the fund has good quality debt papers in the holdings and inspect if the portfolio has exposure to stressed assets.
  
  High churning rate of the securities in the portfolio can negatively impact the overall returns of the scheme. Analyse, the portfolio turnover ratio and expense ratio to assess how efficiently the fund controls the churning and limits the expenses.
Performance review

Once you have selected the schemes based on the above mentioned parameters, or if you have existing schemes in your portfolio, stick to your investment regardless of market conditions. But make sure that you conduct a review of the schemes in your portfolio periodically.

This will help you to weed out any non-performing schemes and replace them with potential winners.

As an investor, it may be difficult for you to evaluate the schemes on all the above mentioned parameters. What you need is superlative research-backed advice to be able to select the right fund for your financial goals and needs.

We, at PersonalFN, select and recommend mutual funds on quantitative and qualitative parameters using our S.M.A.R.T Score Matrix:

S - Systems and Processes

M - Market Cycle Performance

A - Asset Management Style

R - Risk-Reward Ratios

T - Performance Track Record

To know more about selecting winning mutual funds, watch this short video:

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