Mastering your Mutual Fund

In the past few days, I have spent a considerable amount of time on Quora answering questions on mutual funds. Questions covering aspects such as selecting the best mutual fund and how can an individual maximize his returns from mutual funds. Some of the questions I came across are listed below:

While people want to make a quick buck and make investments in the stock market there is a significant problem that acts as a roadblock. Most people suffer from a limited or lack of knowledge in mutual funds and the stock market. When this gets coupled with the fact that they do not wish to hire a good financial planner or spend their own time learning about the intricacies, it becomes a sure shot recipe for doom and failure.

For the remainder of this article, I am going to provide a quick fix solution to the above mentioned problems. I will cover two aspects of mutual funds — Why mutual funds work and How you should choose one

Before I delve into it, here’s a quote for humility and the need to invest in mutual fund learning:

Why Mutual Funds work?

There are multiple reasons for the working of a mutual fund.

As compared to an individual investing in the market and doing his or her own individual research, a mutual fund relies on research from a dedicated trained team. Additionally, with years of experience, a fund manager definitely has the odds in his/her favor when it comes to beating the market

The second major argument in favor of a mutual fund is the fact that it is a pool of funds. Like you several other investors are investing money in the mutual fund building its corpus making it similar to that of any large individual investor who can influence the market. When mutual funds invest in businesses they can pick up significant stakes and talk to the management and even get board seats to influence decision making and make sure your investments provide the maximum possible returns.

Additionally, if you think of this as a pure investment product and were to compare it to other options of investing not only do mutual funds provide better tax benefits to investors(tax free for investments greater than one year in pure equity schemes) they also provide one of the lowest cost structures for investing.

Further, mutual funds beat the market — Hands down and they will continue to do so in the future (unless the financial stock market collapses or there is a world war). In addition to beating inflation and generating superior returns, mutual funds are also better than traditional forms of saving such as gold, property and fixed deposits because they provide ready liquidity and as mentioned previously low costs of investing.

Still not convinced?

Here’s a look at the Top Mutual Fund schemes and their performance

How should you choose a Mutual Fund?

An individual investor should look at four factors while choosing a mutual fund

When I choose a mutual fund there are four things that I look at:

Performance: Some of the questions that I ask myself before investing in a mutual fund:

How has the mutual fund performed in the past 3, 5, 7 and 10 Year periods?

How does the concerned mutual fund compare to its peers?

How have the other funds by this portfolio manager performed?

Portfolio: A portfolio is the most important factor when considering a mutual fund. A portfolio which is full of big names you can identify immediately is a good sign. However, if you see a lot of companies you haven’t heard of or complex instruments like options and futures or companies that you know have a bad reputation, it is recommended that you stay away from the concerned mutual fund. A sure shot winner is one where you have a balance of big names and small and medium companies that can grow into bluechips in the future.

Management: The management of a mutual fund determines how the mutual fund will behave with you. An ethical management ensures that your money is in good hands. Some of the questions you need to ask are:

How is the asset management company’s reputation in the market?
How is the portfolio managers reputation and historical performance?

Risk: Risk is perhaps the hardest to identify. A golden rule to determine your risk is to look at the riskometer provided by the fund house. Brown risk is relatively high risk followed by yellow for moderate and blue for low risk.

I have divided the questions that you need to ask yourself into two blocks. The first help identify the reasons as to why do you wish to invest in a particular mutual fund scheme and the second block deals with whether this is the best mutual fund scheme for you as an individual.

An in-depth analysis prior to investing in a scheme will allow individuals to insulate their investment against risks

By the end of this post I hope that you realize that investing in a mutual fund is no piece of cake. But if you were to just spend about thirty to forty minutes on research you can actually generate superior returns from the mutual fund.