Here's what you should consider before investing in mutual funds

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Deciding to invest your hard-earned money in mutual funds is a big step, and it needs to be done right. With so many options on the table, you need to be careful where you invest as it can seriously affect your returns. But there are over 40 AMCs and hundreds of schemes, plans, and options on offer, which means you have a tough choice to make.

Let us, therefore, discuss the factors that we should all consider before we make up our mind to invest in a particular mutual fund:

Investment objective

This is the most crucial factor of all. The fund that you’ve chosen to invest in must align with your investment objective. Study the fund, check what its objectives are and whether or not it has been consistent in sticking to these objectives. Let us understand this better with the help of an example. Say you want to invest in a debt fund for a stable income stream. It would be pointless then to invest in a fund that adopts a more dynamic approach to rate management.

Volatility

In the investment market, the past performance of a mutual fund matters a lot! A fund that is consistently offering 16% returns with low volatility is much better than a fund offering 18% with high volatility. If you’re going to invest in mutual funds, choose funds that will outperform the index over a prolonged duration; otherwise, you might as well invest in passive funds such as index funds and ETFs. Also, make it a point to consider the risk to reward ratio. A fund offering 14 percent return with manageable risk is preferable to a fund offering 20 percent with high risk.

Longevity of the fund management team

You might be wondering what the longevity of the fund management team has to do with the viability of the fund. Well, if the fund management team stays with a fund for a prolonged period it typically means that the fund is delivering consistently. Fund managers tend to stay with a fund only if it is performing well. If not, they will leave that fund and scout other more profitable opportunities. If you conduct a self-study, you will observe that funds that have performed consistently over time have had stable management teams.

Additional expenses

In the mutual fund business, there are some additional costs/expenses that you should pay attention to as they are billed to your NAV in the form of an expense ratio. For instance, if you exit a fund before the stipulated period, you will be charged an exit fee. The mutual fund also involves other costs like transaction costs for the fund, operational costs, administrative costs, marketing costs, etc., which are debited to the NAV of the fund. Ethically, the fund managers have to disclose the expense ratios and the breakdown of costs transparently. While the equity funds have an expense ratio in the range of 1.5 percent to 2 percent, index funds have much lower expense ratios. Make sure you compare the returns of the funds with the expense ratios to ensure you wouldn’t be charged unnecessarily.

Exit loads and taxes

Regardless of the funds you choose, you will be charged exit loads and taxes, but you should try to understand what their implications will be on your returns. For instance, if you go out to sell equity funds before completing one year, you will have to pay an STCG tax at 15 percent, whereas if you’re selling debt funds before completing 3 years, you will be required to pay an STCG tax of 30 percent (which is the peak rate). Also, make it a point to ensure that the exit loads are as per your expectations (they may range from 0.5 percent to 1 percent). The numbers may not look too high, but when you’re dealing with a sufficient amount of capital, these costs can cut your returns.

Position of the fund respective to the investment curve

Always conduct this analysis before you decide to invest in a fund. It is not feasible for the fund manager to catch on to every trend in the market, but they should catch major trends. If we consider debt funds, the fund manager must be able to adjust the maturity of the portfolio based on interest rate expectations. If we’re discussing hybrid funds, the fund manager should be able to manage the mix of equity and debt smartly. All in all, the fund manager should have the analytical prowess to stay ahead of the investment curve.

As long as you follow these simple guidelines and manage your risk, you should be able to get expected returns from your chosen mutual funds. Happy investing!

The writer, Rachit Chawla, is Director, Finance and Technology at Risers Accelerator. The views expressed are personal