Mutual funds are professionally managed investment programs that gather funds from numerous investors, which are then invested into various types of securities such as bonds, stocks, and short-term debts. The combined holding of the mutual funds is called its portfolio. Each investor who buys shares in a mutual fund thus effectively becomes a part-owner of the fund and receives their share of the returns that the fund generates.
However, choosing the right mutual fund can sometimes feel like a daunting task, particularly for those who are new to the trading world. So, here are some useful tips to help you identify the right mutual funds for you:
1> Identify your own goals and risks
The first step is to make a list of all your financial objectives and classify them as either short-term or long-term, based on whether you are focused on generating current income to meet your immediate expenses, or looking at securing your future via capital gains, respectively.
Moreover, there are different levels of risk involved with every mutual fund, which is why it is important for you to determine your own personal risk tolerance. Simply put, your risk tolerance (or appetite) refers to the amount of risk you are willing to handle as an investor; the more risk you are willing and able to take, the greater the returns you are likely to generate.
2> Fees and expenses
Charging a certain fee from investors is how mutual fund companies make money. Before you make a purchase, it is important to understand the different types of charges associated with each fund.
The most common type of charge is sales fee, known more commonly as ‘load’. Funds may charge a fee at the time of the initial investment (front-end load), or at the time of selling the shares you hold in the fund (back-end load). Some funds, known as no-load funds, may not charge any sales fee. Instead, they charge a management fee in the form of the fund’s expense ratio, which is basically derived by dividing the fund’s operating expenses by the value of its assets under management (AUM). The lower a fund’s expense ratio, the higher the returns on your invested capital.
3> Experience and past performance
You may learn more about a fund’s background basis its past and current performance by looking at the performance of the schemes they have previously managed and are presently managing. Although past performance does not necessarily determine the fund’s ability to generate returns in the future, it does provide a reasonable idea about how volatile or stable the fund has been over time. The more volatile the fund, the larger the investment risk involved, which as explained earlier, will be an important factor to consider against your personal risk tolerance.
4> Understanding different attributes of Mutual Funds
Identifying suitable funds within each asset class is an important step in finding the correct mutual fund for you. To plan out your mutual fund investment journey, you should try to get a clear understanding of the many characteristics associated with mutual funds, such as their performance vis-a-vis industry benchmarks, their consistency over the years, their performance compared to competitors within the same asset class, the different types of securities invested in (equity or debt) and the various types of plans on offer (regular and direct), among others.
5> Legal Aspect
Before you invest in a mutual fund, it is very important to check and ensure that it has fulfilled all its legal obligations, so that you do not get yourself unwittingly involved in any legal inconveniences that follow on account of the fund’s negligence. Be sure to study the fund’s prospectus and go through the shareholder reports carefully, to ensure that the fund is legally compliant and there is no malpractice being conducted.
Investing in mutual funds is not as cumbersome and daunting a task as it is often made out to be, provided you know what all factors to consider and look out for when choosing the ones that are right for you. Hopefully, possessed with the knowledge of the 5 most important factors to consider, you will now feel more confident about selecting and investing in the right mutual funds. It is also always a wise idea to seek advice from a professional financial advisor before investing, as they would be able to provide a more in-depth analysis of your situation and help you find the perfect mutual fund to realize your financial aspirations.