There is no one-size-fits-all “best” mutual fund; rather, the best choice depends on an individual’s goals, risk tolerance, and investment horizon.
Mutual funds are a vast investment space with a variety of funds. As an investing tool, mutual funds are categorised into different asset class types, like equity funds, debt funds, money market funds, hybrid funds, arbitrage funds, and so on.
Now, with so many options available, it’s quite natural to feel confused, and you might be inclined to invest in the best-performing fund. However, just like in life, the definition of “best” varies for everyone; the same applies to mutual funds. There is no single mutual fund that can be deemed the best. Largely, it is your goals that will guide you in selecting the best (suited) mutual fund.
If you are looking to select your initial equity mutual fund but feeling uncertain about where to begin, here are a few points that will help you get started:
- Start by defining your investment goals: Ask yourself why you’re investing and what you aim to achieve (the financial goals). Your goals can include your child’s education abroad, building a retirement fund, or acquiring a vacation property. Understanding this goal will guide you in determining the necessary investment amount to reach your target.
- Then, assess your risk tolerance: Once you have established your goals, evaluate your risk appetite. Are you comfortable with the higher risk associated with equity funds, or do you prefer the stability of low-risk options? Knowing your risk tolerance will assist in selecting the mutual fund that aligns with your comfort level.
- Lastly, determine your time horizon: If your investment timeline spans from one to three years, it is advisable to allocate your funds to debt funds. If your investment timeline falls between three to five years, opting for hybrid funds would be more appropriate. Financial experts commonly recommend considering equity mutual funds only if your investment horizon extends beyond five years.
The choice of mutual funds depends on an individual’s investment goals, risk tolerance, and financial constraints for short, medium, and long-term objectives. Here are some good options you can consider for selecting a mutual fund category:
For short-term goals:
Debt mutual funds
These funds are less risky compared to equity mutual funds. Examples include liquid funds, ultra-short-term funds, and short-term funds.
Liquid funds
Invests primarily in securities with short residual maturities, making them suitable for building emergency funds. They carry minimal risk by investing in short-term securities such as treasury bills, commercial paper, and certificates of deposit with maturities of up to 91 days.
Ultra short-term and short-term funds
Invests mainly in fixed-income securities with slightly higher maturities than liquid funds. Offers good returns and less exposure to interest rate risk (compared to other duration funds).
These funds can be considered for short-term goals like travel or purchasing consumer durables, etc.
For medium-term goals (3-5 years):
Hybrid mutual funds
Balanced mutual funds or hybrid funds invest in both debt and equity, making them suitable for medium-term goals. In this you get to see a whole range of funds with varied exposure to Equity and Debt component in the portfolio. Multi asset allocation funds are a great option to take an exposure including Gold and/or international equities, but in a tax efficient manner (as against if one were to handle the asset classes directly at individual level).
For Long-Term Goals:
Large-cap funds
These funds primarily invest in equity and equity-related instruments of large-cap companies, providing stability compared to other market cap oriented funds.
Mid-cap funds
They invest a minimum of 65% in equities and equity-related products of mid-sized companies, offering potentially higher returns, than a typical Largecap fund, but they come with higher volatility.
Small-cap funds
Allocates at least 65% of investments to equity and equity-related securities of small-size enterprises. Though volatile, they offer significant growth potential in the long run.
Now, once you’ve determined the mutual fund category aligning with your goals, risk tolerance and time horizon, you may wonder how to select the fund that best suits your investment objectives. So here is a list of things to watch out for while choosing your ideal mutual fund:
Consistency in returns
Examine the consistency of a fund’s returns over time. Compare the returns of two funds: one exhibiting returns of 10%, 10.5%, and 12% over three consecutive years, and another with returns of 15%, 2%, and 5.5% over the same period. The first fund showcases superior return consistency compared to the second.
Also, ensure that the fund out performs the peer group and / or the benchmark consistently.
Evaluation of fund managers
Check the proficiency of the fund manager overseeing the specific fund. A skilled fund manager has the capability to transform underperforming mutual funds into top performers. The fund manager plays a pivotal role in dictating the performance of your mutual fund by making decisions regarding stock selection and fund allocation.
A competent fund manager can significantly contribute to a fund’s success; hence fund manager’s track record is a vital check point for scheme selection.
Monitor the exit load
Exit load is the fee charged by the AMCs when investors redeem their mutual fund units prematurely. Ensure that your exit load is zero before redeeming your mutual fund.
Conclusion
With SEBI’s categorisation guidelines, equity schemes are further classified into various categories. Strive to maintain a diversified portfolio across different mutual fund schemes.
Diversification helps to reduce the risk associated with your investment portfolio.
The right investment approach is to find the right mutual fund as per your investment requirements. Doing thorough research based on the points discussed above, and then selecting the right fund for you should be easy.
Head to FundsGenie to learn more about finding the perfect mutual fund for you.
