How to Select Mutual Funds?

Factors to Consider Before Selecting Mutual Funds

Before we move on to how to choose mutual funds, it is important to consider the following three things to make the right decision:

1. Financial goals

The very first thing you need to consider while choosing the right mutual fund is your financial goals and status. It is the most important thing for creating a good investment plan. So, lay out your goals in different stages of life while also factoring in inflation to make a practical plan. This means, identifying how much you want to invest, where you want to invest and for how long you want to invest. 
Once you make these things clear in your mind, you can move on to the procedure of selecting the mutual funds for meeting these objectives. 

2. Risk Appetite

The second important thing to consider before choosing the best mutual fund is your risk appetite i.e how much risk you can tolerate without affecting your financial condition. Different investors have different risk appetites. While some can tolerate higher risk, others can not withstand even the moderate risk levels. Basically, risk appetite depends on a number of factors like age, income, financial condition, stage of life, etc. 
Once you access your risk appetite well, it will become very easy to select the best mutual fund schemes for yourself. 

3. Asset allocation

If you don't already know, different asset classes come with their own risk profiles. For example, equity funds usually carry a higher risk than debt funds. It is very important to understand that risk and returns associated with mutual funds are directly proportional to each other. The main aim behind asset allocation is to maintain a balance between risk and returns to meet your financial goals. So, if your risk appetite is higher, you can invest in equity funds and similarly, if your risk appetite is lower, you can invest in debt funds. Alternatively, you can also balance the risk and returns by investing in both types of funds. 

So, these were the factors you need to consider before investing in mutual funds. Now, let's talk about how to choose mutual funds in India!
 

How to Select Mutual Funds?

Making the right selection of mutual funds is one of the most crucial tasks for investors. Below are some points to look for while selecting the best mutual funds:

Investment Objective 

Before you find out how to choose mutual funds, you need to first identify your investment objective. Ask yourself, do you want to grow your money or want a flow of regular income? In case you want to have a regular source of income, then debt funds are the right choice. However, if you want to grow your income over a long period of time, then there is no better option than investing in equity funds. 

Investment Horizon 

The investment horizon is the time for which you want to stay invested. Note that, equity funds are best for staying invested for the long term, while debt funds are suitable for investors with short-term to medium-term goals. Moreover, if you want to invest for a very short time, say less than a year, then liquid funds, overnight fins and ultra-short duration funds are good options. 

Risk Tolerance 

If you understand your risk tolerance level, you will easily understand how to choose mutual funds in India. Knowing your risk tolerance helps to make sure you don't take more risks than you can handle. If you have a very low or moderate risk appetite, then go for debt or bond funds. However, if your risk tolerance is higher, then you can freely invest in equity funds. 

Taxation

Taxation is another important factor to consider at the time of selecting a mutual fund scheme. You must know the tax consequences before picking your investment instrument. For instance, short-term capital gains in the case of equity funds are taxed at 15%, whereas long-term capital gains are taxed at a rate of 10% and also exempt up to Rs. 1 lakh. Further, short-term capital gains in the case of non-equity funds are taxed as per the income tax slab of the investor, whereas long-term gains are taxed at a rate of 20%. Moreover, indexation benefit is also provided on these gains. 

Investment Mode - Lump sum or SIP?

At the time of selecting a mutual fund, you need to decide what kind of investment mode is more suitable for you. Try to figure out if you want to invest a single lump sum amount or wish to start a SIP (Systematic Investment Plan). If you want to enjoy the power of compounding, then there is no better option than starting a SIP at a fixed interval of time. But if you have a good capital ready to invest, you can choose a lump sum investment as per your allocation. 

Fund Manager 

If you want to make the most out of your mutual fund investment, then pay special attention to your fund house and fund manager. A good idea is to carry out a background check and look at the past performance of the fund manager and fund house you're going to connect with. 

Expense Ratio

Note that all the fund expenses incurred to you will be paid through the returns you've gained. Generally, the expense ratio for funds like ETFs and index funds is very important to know. In the case of actively managed accounts, the ability of any fund manager to generate high returns will surely compensate for your fund expenses. However, both ETFs and Index funds do not have time to generate high alphas, instead, they only track the index. 

And there you have it!

This is how you select mutual funds according to your goals and requirements. Now, to help you a bit more, below are some essential tips to keep in mind while making the right selection. Check them out! 

Additional Tips to Select Mutual Funds

• Don't follow the internet trends and advise blindly. Instead, follow a trusted financial advisor with great knowledge of stock markets, when needed. 
• Do your research before selecting the right investment tool for yourself. 
• Do not over-invest. Fix a budget and invest accordingly. 
• Calculate returns and tax before selecting the right scheme. 

Final Words

Mutual funds offer many benefits for investors with a variety of financial goals, investment horizons, liquidity requirements, and risk appetite. If you follow the information and tips mentioned in this article, you will know how to select mutual funds in India. If you have any difficulties in making the selection, then don't hesitate to ask an experienced professional. We hope this information helps. For more such information, check out 5Paisa!