5 Things to Consider Before Choosing a Mutual Fund

1. Know your financial goal:

Before picking a mutual fund, ask yourself an important question: What exactly are you saving and investing for? To make a right investment decision it is very crucial to link it with a goal (Goal-based investing). This goal could be the purchase of a new luxury car or house, saving for your child’s education or a vacation abroad.  Mapping out all your needs gives you a clearer picture and the time for which you need to stay invested to achieve each goal. 

Depending on the goal, one will able to determine the right mutual fund category – debt mutual fund, equity mutual fund, or hybrid mutual fund.

• For short-term goals, an investor should opt for debt mutual funds.
• For medium-term goal like child education, an investor can begin investing in an equity fund and gradually shift towards debt mutual funds as he/she come nearer to his/her goals.
• For long-term goals, an investor can consider equity funds because they are best placed to give you inflation-beating higher returns in the long run.

There is a plethora of schemes in the market, each with a unique investment objective. Invest in a mutual fund scheme which you share a common investment objective with.

2. Do your research:

When it comes to choosing the right mutual fund, there are various parameters to look into – return expectations, risk level, investment horizon, etc., and the quality of the mutual funds can be judged based on past performance, assets under management (AUM), fund manager’s experience & track record, and more. It is crucial to conduct a certain degree of preliminary research before beginning your investment journey as the research will help you make a more informed choice and enable you to get a clear idea of the “what is what” in the mutual fund space.

Few of the parameters to consider are:

a. Performance against benchmarks

Every mutual fund publishes data about the benchmark index against which it is pitted. For example, the BSE Sensex or NIFTY index is the benchmark for some equity funds. Look at the benchmarks of funds and how they have performed in its comparison.

b. Performance within Peers

Analyse your chosen funds’ performance against other similar funds. You can look at their historical returns, ratios, debt profile, management and more to make your decision.

c. Consistency of Performance

Look at the performance of your chosen mutual fund over the period of time.

d. Exit Loads

These are charges that the fund house imposes on you while redeeming from the fund.

e. Scheme’s AUM

Asset Under Management (AUM) is the total value of all the assets managed by the scheme. This can give you an idea about the size of the fund house.

f. Fund Managers’ Past Performance and Experience

You can look at the fund manager’s profile and past and present performance by looking into the performance of the schemes they have managed in the past and are managing currently.

Contact Net Brokers to help you choose the right mutual fund to chart your mutual fund investment journey.

3. Know the risk profile:

The very first thing for any investor to do before making any investment decision is to know the risk involved with an investment. An individual’s risk appetite might play an essential role in deciding which type of mutual fund is more suitable for you. But it is equally important to understand the risks that come with each mutual fund and whether it aligns with your risk appetite.

For example, equity mutual funds come with a higher degree of risk and the mutual fund portfolio may see some ups and downs in the short term. But the returns from equity mutual funds are often higher as compared to other type of funds, making them suitable for moderate to aggressive investors who are willing to go with the “high risk high-reward approach”.

On the other hand, debt mutual funds involve lesser risk and are more stable, but the returns are usually lower than equity mutual funds and are often ideal for conservative investors.

Risk-adjusted measures such as Sharpe ratio, information ratio is some of the important performance metrics to evaluate the relative performance of a scheme versus its peers and the benchmark.

4. Know the taxation impact:

Tax consideration is something that investors must not overlook.

Tax on equity mutual funds: The returns from equity mutual funds in India are taxed based on the holding period and the applicable tax rate. Mutual funds are often efficient in terms of post-tax returns. For instance, long-term capital gains (12 months and above) are taxed at 10% over and above the exemption limit of INR 1 lakh while short-term capital gains (less than 12 months) are taxed at a rate of 15%.

Tax on debt mutual funds: The minimum holding period for short term capital gains in debt funds is 3 years. Short term capital gains (if the units are sold before three years) in debt mutual funds are taxed as per applicable tax rate of the investor. Therefore, if your tax rate is 30% then short term capital gains tax on debt fund is 30% + 4% cess. Long term capital gains of debt fund are taxed at 20% with indexation. 

There are also type of equity mutual funds – ELSS (equity linked saving schemes) which are tax-saving mutual funds that invest the major portion of the investment corpus in equity and equity-related instruments. ELSS funds are also called tax-saving schemes as they offer tax exemption of up to Rs 1.5 lakh from your annual taxable income under Section 80C of the Income Tax Act.