How to find your ideal mutual fund
Having too many options is never a good thing
If you’re trying to cross the milestone of making your first investment, then, almost everybody will tell you to begin from mutual funds.
And when you ask them: why mutual funds?
They’ll say things like, “Mutual funds are safe” and “they’re easy to invest in”.
While they’re not completely wrong, they just seem to be a little out of touch with the number and types of mutual funds available these days. Just to put this into perspective, as of 2019, there are at least 44 mutual fund houses, offering upwards of 2500 mutual funds.
While having options is a good thing, having 2500 isn’t always the best. This makes it difficult to identify the good funds, especially when most look similar.
This article is divided into 4 simple sections:
- Identifying your investment timeline and objective
- Different kinds of mutual funds
- Evaluating a fund
- Choosing your reinvestment strategy
1. Identifying your investment timeline and objective:
The whole point of investing is to grow your money till it’s put to use. There is money which you won’t need for a long period of time, so you can invest it in funds suited to deliver that. Then you have money that is going to sit idle only for a small period of time, in such a scenario you can invest in funds that aren’t very volatile and are designed to provide liquidity.
Another reason why it helps to be aware of investment timelines is because, funds apply charges — or penalties — on investments which are pulled out before the stipulated time has elapsed. These time windows differ from fund to fund.
Suppose, you exit an investment in an equity fund — which is designed for long term investments — in 2 months, then, an exit load of certain percentage is levied on your total investment. But, if you had known that you’d be only investing for a few months and therefore chosen a fund designed for short term investments, like Liquid fund, then, you wouldn’t have to pay any exit load at all.
2. Different kinds of mutual funds:
Large cap/ Blue chip funds:
These funds invest in only stocks of large and established corporations. Such stocks are less volatile during rough markets and give almost consistent returns, almost. These organisations tend to grow more slowly but consistently, and as a consequence, are less risky. So chances of making a quick profit are low, but make for great long term investments.
Mid cap funds:
These invest in stocks of slightly smaller companies and are more volatile than large cap funds, and can therefore give you relatively greater profits and greater losses.
Small cap funds:
These are smaller companies that you might not have heard of, but, because they’re small, they have a lot of headroom left to grow and can give even greater returns compared to the large and mid cap stocks. But they are generally more vulnerable in rough markets and can fall just as quickly as they can rise. Greater the risk, greater the reward.
Multi cap funds:
These funds have a portfolio that’s made up of combination of stocks of all sizes and are inherently less riskier.
Debt funds:
Debt funds invest in bonds, rather than stocks.
But wait, what’s a bond?
Bonds are securities which are used by companies and governments to raise funds. At its core, a bond is a loan through which the public lends these bodies money and the loaned amount earns a fixed rate of interest in return.
These are highly risk averse investments and assure fixed returns, but as is the nature of investments — or anything else under the sun — low risk equals low reward.
Arbitrage/ Hybrid funds:
You guessed it, these have a mix of stocks and bonds in their portfolio. So the volatility of the markets are balanced by stable and assured returns of bonds.
Index funds:
These are funds that create a portfolio of stocks, imitating an index. There’s no picking and choosing of stocks, they simply invest in all the stocks present in the index that they’re following. This reduces the fund’s operating cost, consequently reducing the expense ratio.
Liquid funds:
Learn what makes liquid funds safe and great investments for the short term here.
International funds:
When a big storm hits any country, then, almost all of its securities and markets fall. And this deals a huge blow to the investors. So, to save your portfolio from crumbling completely, you diversify.
You ensure that you spread your investments across different industries and securities, hoping that, in the event of an economic meltdown of a particular industry, others stay safe.
But, if you want a more robust way of isolating your investments, you head towards markets of other countries. While it is difficult for a person to invest in markets of other countries, they can easily do so with the help of international mutual funds.
These funds invest in securities of other countries, providing the investors with an easy path to diversification.
GILT funds:
These funds invest exclusively in government securities, making the investments hugely risk free, as the government rarely defaults on its payments.
3. Evaluating a fund:
After identifying the duration and purpose of the investment, you would then estimate the level of risk and then go on to pick the type of fund from the list above, meeting your requirements.
But when the time comes to pick a fund, you’ll find that there are more options than you can keep track of, and most, if not all, have very similar stats, leaving you scratching your head.
But with a little bit of help, you should be good to go. What you’re gonna read below will help.
Consistent returns:
When you’re giving your money to someone to invest, you’d want to make sure that they know what they’re doing. And one of the ways which’ll tell you this are historic returns.
Start with the returns generated since the fund’s inception and work your way towards more recent times.
You’re looking for stable returns or consistent growth in them over a period of time.
And one of the more important things to do here, would be to compare these stats with those of other similar funds. Most websites will show you these comparisons very conveniently, making it easier for you to get a better picture.
Asset Under Management:
AUM or Asset under management represents the total amount of investor money that the fund is handling.
The greater the number, the greater the people’s trust.
Expense ratio:
This metric tells you how much money the fund is spending to keep its operations running. Operations that include the team’s salary, transaction costs, etc. The lower the value, the better.
You need to pay attention to this value, because these costs come out of the AUM — the money that you’ve invested.
What’s important here is that you find out how the expense ratio of your fund compares with other similar funds.
Expense ratios vary from category to category, for example: index funds tend to have one of the lowest expense ratios, while small/ large/ multi cap tend to have greater ratios.
Fund’s portfolio:
Once you’ve shortlisted a few funds, go through the fun’s portfolio and see what kinds of securities it’s investing in. Are they volatile or stable? If the holdings are diversified or are they concentrated in a few securities?
Finding answers to such questions would allow you to get more insight into the fund and it’s performance.
4. Reinvestment strategy:
When you start searching for mutual funds, you’ll notice that each fund has a couple of variations, in that, there will be one of these suffixes added to the fund: direct, growth, dividend payout, and dividend reinvestment.
Some of these names are self explanatory, while others not so much. But, knowing the difference between them will make a great deal of difference to your investments.
Direct:
This means that the you’re investing directly in the fund via the Asset management company’s (AMC) website. This means that there will be no commission or brokerage that you’ll be paying to any intermediary, which would be your trading account provider or broker. Greater gains.
Regular:
You will choose this plan when you’re investing via an intermediary like a broker, advisor, or distributor. These intermediaries will take a commission from the AMC, which will in turn recover the costs from you. So you will incur relatively greater expenses. But the cost is justified if you’re new to investing and decide to start with the help of an advisor.
Growth:
A growth plan will not hand out dividends or regular cash payments, but instead, it will reinvest that money to increase the Net Asset Value (or NAV) of your mutual fund units. What this means is that, if you and your friend held the same number of units of a mutual fund, say 10 units of fund XYZ, but you have opted for a growth plan and your friend a dividend pay out plan, then, at the end of a year both of you would still hold 10 units, but your 10 units would be worth more as you chose to reinvest your divined money to increase the price of your units.
Dividend reinvestment:
This plan is similar to growth, as it too reinvests the dividend. But, in this case the dividend money is used to buy extra units of the fund, instead of increasing the NAV.
Dividend payout:
In this situation, you are simply handed the dividends from your investments In periodic cash payments. This is preferable if you require a constant source of revenue.
Armed with this knowledge you will now be able to make a more educated choice, rather than just picking the first fund showing green.
You’re part of an exclusive club now
Not many people have a clear idea about all the things that you just learnt about and that too at your age, assuming that you’re relatively young.
Now, empowered with this knowledge, you’ll find your self cruising more effortlessly through the financial part of adulting than your peers.
Which brings us to the most important responsibility that all members of this club have, that is to educate people around you on financial literacy and give them the same gift of empowerment that you have received.
Why does Let’s Talk Money exist?
To empower you.
Because, we understand the impact that the knowledge of a new tool or skill can have on somebody’s life.
And, financial literacy is one of those tools. It holds the potential, if harnessed, to change the entire course of a person’s life. Which is why we are working towards making the conversation around it more fun and engaging so that we can empower as many people as we can.
What you need to know before putting your money into mutual funds
Have you made your first investment yet?
If not, read the series of articles covering why you should invest to how you can get started.
Write For Let’s Talk Money
Did this story help you? or did you have an unique experience/ observation that others could benefit from knowing about?
If you want your story to reach young readers and inspire them to become financially literate, then share your story, here, on Let’s Talk Money.
Be heard and impact people’s lives.
Find the steps to get published on this publication in the link below.
