Mutual funds are all around us these days. You must have seen multiple ads in television as well as on web stating the importance of mutual funds as a means to achieve your goals. A funny ad from a popular mutual fund AMC says that not everyone can spot the potential early. Few years ago, Investmentyogi also posted a light hearted video on how to invest in mutual funds.
Is it enough to know the importance of mutual fund investment? Definitely not. You need to learn the art of buying mutual funds for the right goal i.e. you should aim to become a professional in mutual fund investment. Understanding mutual funds takes time. Mutual fund industry in India has different types of mutual fund schemes, which results in a lot of confusion on which scheme to pick.
Though it’s tough to master this art, if you are follow certain guidelines you can be on the path of doing so. Here is a mutual fund investment guide to help you become a mutual fund professional.
(Also see: Why people don’t invest in mutual funds)
1) Consistency matters the most
Mutual funds are essentially a long term product. You need to have patience to make money in them. If you have trading instincts such as buying or selling frequently, let go of them first. If you are investing in equity funds, this is even more significant. A couple of good market days may give a boost to your portfolio but at the same time a dip in the market can even destroy your portfolio. There is only one solution to this. Have patience. If you believe you have invested in the right fund which has all the ingredients in helping you reach your goal, then why bother? Stay in it till your goal is reached.
‘Stay invested for long term’ is a very common phrase to state these days. But, does it really work? Let’s pick a fund and see how it performed in a span of 10 years.
The most important column which you should be concentrating upon in the above graph is ‘total return’ rather than mutual fund NAV, benchmark, etc. Let’s assume you have invested in the HDFC top 200 fund in the year 2000. If you are an emotional investor, you would have definitely sold the units of this fund within 2 years when the fund had delivered annualized returns of -25.47% and -10.13%. However, you were an intelligent investor who believes in the fund’s potential, you would not have panicked. The results are there for you. After 10 years, your returns would have been 37.53% p.a. You would have needed returns from 4 fixed deposits to match this. I am not trying to do a Mutual Fund vs FD here. All am trying to say is that consistency is the key to success.
(Use our SIP Maturity Calculator to know the final maturity amount of your SIP investment.)
2) Do your own research
Yes, mutual fund returns is the most important aspect to look at. But, what affects returns are other factors such as expense ratio, fund manager, etc. Lower expense ratio means lower charges for you. A lot of times leaving of a good fund manager can negatively impact the fund’s returns.
Fund manager is the heart of a mutual fund. He makes strategic decisions such as asset allocation and stock picking. However, do not immediately react if the fund manager has left the fund and new one has taken over. Give him some time. Within a time of 4-6 months you should be able to know how he is handling the fund.
So, do your own research on the fund you want to pick. Everything is available in the internet now. You just have to spare time for it.
(Also see: Seven reasons why mutual funds fail)
3) Diversification means more variety and not quantity
The moment I talk about diversification, there is a strong response that diversification should be done using 4-6 funds. Diversification is more about variety than quantity. If you choose 3 best large cap funds and 3 best mid cap funds, you are not diversifying. Splitting your investment in different funds in different proportions is the most important part here. In the financial space, this is called Asset Allocation.
4) Choose the fund based on your risk and need
Before picking any mutual fund, know your risk appetite. Are you ok to stay in this fund despite hiccups in it? If you believe you cannot take risk, pick conservative mutual funds such as debt funds or balanced funds (which have debt component). The second point to note here is your need/goal. If your goal is 2 years away, there is no point in picking even the best equity fund. You should be investing in a debt fund which invests in short term securities such as commercial papers, bonds, treasury bills, etc. If your need is good returns plus liquidity, opt for liquid funds. Mix your risk and need to know which category of funds suit you.
5) Monitor your fund
Always monitor the funds you have invested in. Till now, we have been telling you to stay invested in the fund and not buy/sell frequently. You must be wondering, why monitor then? Monitoring does not mean taking action compulsorily. It just means tracking. Check how your fund has been performing. If the fund is moving as per your expectations, it’s well and good. But, if something went wrong, know what went wrong. Is there a fundamental issue with the fund or is it just a victim of the market?
If you follow these five things consistently, you will get a hold of what mutual funds are how to choose them. You will eventually become a mutual fund expert as time goes by.