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You can earn high returns from mutual funds in a safe manner. A mutual fund is managed by a team of professionals with many years of experience. You just have to browse the options, pick the best one, and park your money. However, it can be challenging to decide which mutual fund scheme to invest in. Especially since fund houses offer a variety of schemes, such as growth, income, liquid, ELSS, and funds of funds. Find out how to choose mutual funds in this article. The criteria for selecting mutual funds are explained in detail for how to choose mutual funds.
Factors to Look at Before Choosing Mutual Funds
The mutual fund industry provides investment solutions for investors of all ages. You can choose a mutual fund for wealth creation, children's higher education, vacation planning, property purchase, or income generation during retirement. Nevertheless, the most important question arises: How to select mutual funds that will meet your investment goals?
To understand how to choose mutual funds, you need to be aware of the following three things:
Financial Goals
It is most important to define different financial goals before preparing an investment plan. Lay out all your financial goals in stages of life, taking inflation into account. So that you have a clearly defined action plan, such as how much and where to invest and for how long! Then, you should think about how to select mutual funds that can help you reach these goals.
Risk Appetite
The concept of risk refers to the probability that your financial expectations are not met. Risk-taking capacity varies from person to person. The level of risk you are willing to take depends on your age, stage of life, personal circumstances, and financial situation. You can choose a mutual fund based on your risk appetite if you can assess your risk well.
Asset allocation
The risk profile of different asset classes differs. For example, debt funds have lower risk than equity funds. It is important to understand that risk and return are directly related. To achieve your financial goals, asset allocation aims to balance risk and return.
You can have a higher allocation to equities if you have a higher risk appetite and vice versa. For that, you need to know how to choose mutual funds in accordance with your financial goal and risk appetite.
How To Choose Mutual Funds In India?
Considering the criteria for selection of mutual funds below, you will know how to select mutual funds according to your financial goals, risk appetite, and asset allocation.
Identify Your Goal
Before investing in a fund, define your investment goals. Does your priority seem to be present income or long-term financial gains? Plan how much, where, and how long to invest for each period of your life, taking inflation into account! Having prepared these goals, you should consider how to choose mutual funds that can help you reach them.
You can choose the best mutual fund type depending on why you are investing. The funds can be debt funds, equity funds, or hybrid funds.
Investment Strategy
Many investors ignore investing strategy when they identify how to select mutual funds. However, it holds a key place in your investment portfolio. Investment strategies are also called investment approaches. It is a method through which fund houses make all investment decisions. A conflict of interest will arise if the fund house's investment strategy does not align with yours. In the end, this will lead to you exiting the investments at an unfavourable price.
Fund Type
You will be able to build a portfolio that matches your financial objectives by understanding the different types of mutual funds. Depending on your investment objectives, you can invest in a particular fund type. For your portfolio, you can choose from the following types of funds:
Mutual Funds For Growth
A growth mutual fund generally invests in growth stocks. As the name implies, Growth Mutual funds are intended to maximise capital gains. In addition, they have a high-risk rating and are not ideal for long-term investments.
Mutual Funds For Income
Fixed-income mutual funds include debt mutual funds. Various income assets are invested in these funds, including debt securities, bonds, and securities. The fund managers of income mutual funds ensure that capital is preserved while also generating a consistent income for investors. It is an appropriate investment for those who are risk-averse and want to keep their money for at least two to three years.
Mutual Funds That Save Taxes
A tax-saving mutual fund, also called an equity-linked savings scheme (ELSS), invests in equity investments. Under Section 80C of the Income Tax Act, funds invested in these programs are deductible. In spite of their high risk, they can yield substantial returns if the fund performs well.
Liquid Mutual Funds
In liquid mutual funds, the money is mainly invested in short-term and ultra-short-term securities, such as commercial papers, certificates of deposit, treasury bills, and others. The primary purpose of liquid mutual funds is to provide liquidity. The risks are low, and the rewards are moderate. A liquid mutual fund is an excellent option for investors seeking short-term investment options.
Fund Performance
Fund Performance matters when understanding how to select mutual funds. It should be considered within a reasonable timeframe. The purpose of this is to ensure that the investments have gone through multiple market cycles. Over time, this would enable consistent returns.
The fund might not be a good investment if it hasn't been able to beat its benchmark over the last three, five, seven, or ten years. To evaluate a fund's performance, research the fund manager's or the fund management team's performance. You would benefit from a strong, experienced, stable, and proven fund management team.
Expense Ratio
An expense ratio refers to the commission or fee investors pay for investment management. For the purpose of ensuring profits across investments, all investors pay the fund manager's fee.
As an investor, you should seek out mutual funds with low expense ratios. The percentage may seem small, but when compared to the total size of your portfolio, it will have a significant impact.
Entry And Exit Load
An entry load is a fee that fund houses charge investors. An exit load is a fee charged when an investor exits a mutual fund scheme. This is charged only to investors who exit within a short timeframe. The goal is to discourage quick exits and immediate outflows of cash from fund houses.
However, the majority of fund houses have removed the entry load. As an investor, you should look for mutual fund schemes with zero or minimal entry and exit loads.
Taxes
As an investor, your investment returns are taxable under the Income Tax Act. Returns on equity fund units are taxable based on the holding period.
Equity funds are taxed on Long Term Capital Gains (holding period of 12 months and more) at 10% over and above their Rs 1 lakh exemption limit. The tax rate on short-term capital gains (holding periods less than 12 months) is 15%.
Direct Plans
In a mutual fund scheme, there are two types of plans: direct and regular. Direct investing allows investors to purchase NAV units directly from a fund house. Regular units have to be bought through a broker or commissioner.
Returns are slightly higher in a direct Mutual Fund since commissions are not incurred. Depending on the asset management company and brokerage firm, this commission varies from 1-1.25%.
In the case of regular Mutual Funds, the Asset Management Company (AMC) pays a brokerage firm a commission for increasing its clientele. In turn, this reduces the total return generated by the investment.
Conclusion
In selecting mutual funds in India, it is important to consider your financial goals, risk tolerance, and asset allocation preferences. To make informed investment decisions, know your investment goals, understand different fund types, evaluate investment strategies, consider fund performance, expense ratio, entry/exit loads, taxes, and plan type. Share India offers the opportunity to explore and invest in various financial instruments, including mutual funds. Those seeking to make informed investment decisions can benefit from their services.
