How to select Mutual Funds in India?

You are here means, you are looking for the answer to the query: How to select mutual funds in India? This implies that you have started your financial planning and you want to invest in Mutual Funds in India.

So, you browse through the internet to try and find the best mutual funds that you should invest in. To your surprise, you discover hundreds of fund houses and tons of funds from these fund houses making the process to choose the funds even more complex. This blog discusses the various important aspects that you should think of while choosing the Mutual Funds best suited to your investment style and risk profile.

Here is a simple image to better describe the steps of choosing a mutual fund. We shall be explaining this framework in greater details further in this post.How to chose mutual fund, select mutual fund, mutual funds selection, mutual funds


Mutual Fund Selection Criteria: How to choose one?

1. Understanding your Investment goals:

Few questions to ask yourself are: What do you want out of this investment? Do you want long term capital appreciation? Do you want quick liquidity? What is your time horizon? Do you want regular income? or Are you are more interested in growth of your capital? Broadly your Investment goal can be: You either want regular income or you want capital appreciation!

Here, we shall also summarise, how your investment goals translate into mutual fund selection, so keep reading on.

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2. Assess your risk profile:

Before choosing a mutual fund and for that matter any investment, understand the risk return equation. Higher returns come with higher risk. In next section, we shall explain, how to measure risk in mutual funds. But, before doing this, you should try to gauge what is your risk appetite. There are very simple risk assessment tools around that can help you understand your risk profile.

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3. Right Asset Allocation:

Based on your investment goals and risk profile, you need to arrive at the right asset allocation. Analyse your short term as well as long term objectives and then go for a combination of different asset classes.

4. Know the key Ratios:

In any investment that you do, you want some degree of consistency of returns. No one likes an investment which gives a very high return in one year and very low returns next year. A volatility factor is always attached while investing in Mutual funds. Good Mutual funds can outperform markets both in good and bad times over 3-5 years and hence have lesser volatility.

Mutual Funds Selection: Key Indicators to check

Key Indicators that can be used for understanding the performance of your mutual fund are provided in the table below. You can also calculate Risk return score for every mutual fund.

Key Metrics  What does it Measure and what to look for?
Beta Beta measures funds volatility in comparison to a benchmark index. Beta of 1 means fund will move as much as the index. If beta is 2 means for X% movement on benchmark fund NAV will move by 2X. Generally, a lower beta with higher returns is considered good.
Standard Deviation Standard deviation measures changes (deviation) in fund returns over a period of time. So, it defines how much Fund returns deviates from historical means, which is an indicator of volatility of funds. In simple terms, if fund has 10 % average rate of return and a 2% standard deviation, its returns will be in the range of 8-12% and lower standard deviation means greater predictability hence lower risk.
Alpha Alpha measures excess returns that fund provides in comparison to a benchmark index. Lets say, if you have a large cap mutual fund, alpha will measure the excess return over the benchmark i.e Large cap index.
Sharpe Ratio Sharpe ratio measures the performance of funds vis-a-vis the risk it has taken by it. So, it is the ratio of excess return over the risk free rate and Standard deviation. The higher the sharpe ratio, the better is the performance of the fund.
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5. Quality of Fund house and Fund Manager:

While one can keep on looking at key ratios and how the mutual fund is performing, Quality of fund house can also impact the future performance of the fund. Good quality fund houses bring professional management, transparent processed and attract good quality fund managers. Selecting high quality fund houses, with Fund Managers having proven track record of performance proves better.

6. Expense Ratio:

Expense ratio measures the annual expenditures made by the fund as a ratio of total assets under management. Expenses includes operational cost, salaries of Fund employees, marketing and distribution costs. The lower the size of the fund, higher the expense ratio. As the fund starts doing well, it attracts larger investments. Hence, its expense ratio should drop. Good funds (equity) should have expense ratio in the range of 1.9-2.0 %, lower the expense ratio higher are the funds available for investment. Debt funds have much lower expense ratios.

Disclaimer: is not an advisory firm. This post is for informational purpose only and should not be constituted as professional advice in any regard. The funds here are just used as examples. Please use your due diligence before investing.

What is your opinion on mutual funds as a growing investment tool in India? What is your mutual fund selection criteria and how do you prefer choosing one? Feel free to drop in your comments below and remember to be cautious while investing your money in any of the risky asset classes.

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