Which mutual fund should you pick? Insights into goal setting & fund picking

Last Updated: Thu, May 11, 2017 17:37 hrs
Mutual Funds (Reuters image)

There are thousands of mutual fund schemes, being offered by the dozens of fund houses in India. For a first-time investor, it's hard to zero in on the best fund. There's far too much information on the internet about the best funds. How does the investor make up his mind?

We believe that before you pick an investment tool, you must have an investment objective. Once you have set an objective (and objectives typically have a timeline), you can shortlist the instruments that will help you achieve it.

We'll divide all possible money objectives into three segments: short, medium, and long-term objectives.

Short Term Objectives
Tenure:
0-2 year

A financial objective for the short term means that your fund requirements would be due soon. Therefore, you need the money to be in a safe and liquid instrument. Also, the money should be protected from elements such as exit loads, expense ratios and market volatility, which erode the fund value.

Possible objectives:

  • You have funds that you want to temporarily park without any risks.

  • You want to build an emergency fund.

  • You want to keep money in a safe, liquid instrument for a holiday fund.

What are your fund options?

You can buy a liquid mutual fund, which helps you invest in low-risk havens such as treasury bills, money market instruments, and certificates of deposit. Your returns would be comparable to fixed deposits. Also, you can redeem your funds without any exit load, which makes liquid funds an excellent tool for short-term deposits. Up to Rs. 50,000 of your liquid fund units can now be redeemed instantly, just as you would redeem a bank deposit. Unlike a bank deposit where you may be charged a TDS, you will be taxed on your liquid funds returns only when you redeem them.

Medium Term Objectives
Tenure:
2-5 years

These are mid-distance financial objectives. Though you need safety of capital, you can afford to introduce a degree of risk. This could help you achieve higher than average returns.

Possible objectives:

  • You are raising money for a down payment on a house or car.

  • You are creating a fund to start a business.

What are your fund options?

Consider investing in debt mutual funds and hybrid mutual funds. Debt funds invest in a mix of fixed income instruments such as government securities, certificates of deposit, debentures, and money market instruments. These are low-risk instruments with conservative returns. Hybrid mutual funds invest in a combination of debt and equity securities. An equity-oriented fund invests primarily (65% or more) in equity and the rest in debt and other options. A debt-oriented fund (such as monthly income plans) invests 70-90% in debt instruments and the rest in equity. Depending on how far your investment horizon is, you can take on higher risks for better returns.

Long Term Objectives
Tenure:
5 years or more

These are long-distance goals that could range from buying a house in five years to sending your child to college in 15 years to retiring in 30 years. It is advisable to invest-at least in part-in equity securities. Equity mutual funds can help you achieve your long-term goals in a more cost-efficient and time-efficient manner.

Possible objectives:

  • Creating a college fund for your child

  • Creating a retirement corpus

  • Buying a second home

You can invest in a mix of equity mutual funds. Depending on your risk appetite and investment horizon, you can take moderate risks or aggressive risks, and a calibrated combination of both. If you are risk-averse, you can consider equity-oriented hybrid funds. If you're seeking moderate risk, you can go with large-cap equity mutual funds, which are moderately volatile. If you seek aggressive risks, you can try small and mid-cap funds, international funds, and sectoral or thematic funds. The higher the risk, the greater the possibility of high rewards or high volatility.

Ideally, you should invest in any mutual fund class through SIPs. This way, you can reduce volatility, optimise risks and returns, and reduce your purchase costs. Before you pick any mutual fund, have a look at its track record, expense ratio, turnover ratio, and underlying assets.

CRISIL AMFI Mutual Fund Category Performance Index*

 

Category

CAGR

 1 Year

2 Years

3 Years

4 Years

5 Years

7 Years

10 Years

Debt

10.17

8.6

9.85

8.77

9.09

8.5

8.54

Liquid

7.2

7.69

8.1

8.41

8.53

8.22

7.8

Equity (All)

25.88

8.38

19.08

19.55

16.66

12.46

12.89

L-Cap Equity

23.37

6.94

15.46

16.49

14.38

11.02

11.74

M-Cap / S Cap Equity

31.04

12.25

26.79

26.59

22.47

16.98

15.05

Hybrid (All)

20.82

9.19

15.98

15.27

13.6

11.59

12.22

Balanced Funds

22.09

9.04

17.7

17.85

15.31

12.62

13.32

MIPs

14.95

8.66

12.56

11.47

10.88

9.63

9.89

For March 30, 2017.

(The writer is CEO, BankBazaar.com. * Data via CRISIL AMFI Performance Indices)

Adhil Shetty is the CEO of BankBazaar.com. Also the co-founder of the company.

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