How to Choose Mutual Funds?

In the past, people earned, saved and piled the savings in the savings account to achieve their short and long term goals. Nowadays, people prefer to invest their money in financial instruments that offer them much higher returns than savings accounts. To accumulate wealth and fulfil their goals, investors are increasingly turning towards mutual funds investment, by far one of the most popular forms of investment for risk-averse investors.

However, once you decide to invest in mutual funds, you are faced with the arduous task of choosing from hundreds of different mutual fund types. How does a beginner investor choose one or two mutual funds from so many different types?

Through this guide, we’ll help you choose the right type of mutual fund that will be suitable for you. Read on to know more about how to choose mutual funds in India.

With mutual funds, new investors always ask the same question: ‘Which is the best mutual fund to invest in?’ In short, they put the bonus of investment entirely on the fund itself. The problem with this approach is that all mutual funds are one-fits-all. Therefore, the right question should be: ‘Why am I investing and what do I need from this investment?’. It immediately puts things into perspective as now you have a goal or goals in mind that you want to fulfil using your investment. INVESTMENT GOALS CAN BE:

Investment goals can be:

• Buy a car or a house

• Go on a foreign vacation

• Prepare for children’s education expenses

• Prepare funds for retirement

• Prepare for children’s marriage

Think about how long you want to remain invested?

Now that you have a goal in mind, you can easily determine the period in which you want to achieve the set goals. For example, buying a car or a house is a short term goal, while preparing for retirement is a long term goal. In the case of short term goals, the risk that you should take in mutual funds should be as low as possible. However, you can take more risks for longer-term goals because mutual funds almost always give better returns in the long run.

An important factor while considering mutual funds is to find out whether your goal is adequate and add value. Your home loan payment and your children’s education or marriage are non-negotiable goals that you must fulfil. On the other hand, planning a vacation or buying a car are negotiable goals that you can postpone if you do not have adequate funds. A non-negotiable goal requires investment with stable returns and low risk as it will add value to your overall financial future.

How to choose the best Mutual Fund?

You can choose an ideal mutual fund by combining these factors.

To understand the above table, you must first understand that debt funds have the lowest risks; equity funds have higher risks while balanced funds are a combination of the two.

 

Example A

You want to invest and accumulate funds for your 8-year-old child’s college education. You know that a college education is a non-negotiable goal, and since your child will require a college education at roughly 18 years of age, you have ten years to accumulate funds, making it a long term goal. For non-negotiable, long term goals, mutual funds investing in equity will be your best bet since they will generate high returns in the longer run.

Example B

You want to start saving for your son or daughter’s marriage, expected in the next 2-3 years. It is a short term, non-negotiable goal. In this case, your best bet would be to invest in debt-oriented mutual funds because they will give stable returns in 2-3 years with less volatility as opposed to equity funds.

With an approach that makes you ask questions to yourself, you can easily narrow down your options for investing in mutual funds. It is always best not to look for the ‘best’ mutual fund before determining your short term or long term goals. Once you do, you can contact a financial advisor for identifying and choose a suitable mutual fund for yourself.