Everyday Money: 3 Parameters of Choosing A Mutual Fund Scheme
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“Which is the best performing mutual fund?” This is a commonly asked question by investors, however, a wrong one. The correct question to ask should be which is the right mutual fund for me?
The right mutual fund to include in your investment portfolio should be best suited to your risk appetite, financial goals, investment horizon and be a top performer within its category. Having said that, a top performing fund cannot be selected only by looking at the star rating of the fund given by a star rating agency.
Consider these three parameters when choosing a fund to invest in:
Investment Goal and Horizon
Well defined goals help make better investment decisions. These goals can be short-(1-2 years), mid- (3-5 years), and long-term (>5 years) depending on how far away the goal is. Investment horizon determines the risk you can take with a mutual fund.
Related Read: Importance of Goal-Based Investing
For instance, if you want to save for a vacation next year, you can park your savings in an ultra short-term or a liquid fund. These funds are not subject to market volatility as they invest in short-term papers, making them suitable for short-term needs. On the other hand, you can take more risks for your child’s education goal that is 10 years away. Equity funds are capable of delivering 13-18 per cent returns over an investment period of 10 years. At the same time, for a short term of 2-3 years, equity funds are capable of eroding your savings depending on the market conditions.
After goals, risk appetite is the second major factor to consider when choosing a fund. Equity funds are extremely volatile whereas debt funds are least affected by market conditions. Hybrid funds balance market volatility by spreading investments across equity and debt.
Related Read: Types of Mutual Funds
Equity funds are suitable for a long-term goal, but someone who can easily get affected by market movements should not choose them even for a long-term goal. A moderate risk investor can opt for an equity-oriented hybrid fund for long terms goal. These funds allocate 60-70 per cent in equity and the rest in debt.
Performance of the Fund
Performance of a fund should be compared with its peers in the same category and not across segments. Comparing a mid-cap and a multi-cap fund will not give you correct information. Instead, within the mid-cap (or multi-cap) category, choose a fund that has consistently performed for more than five years.