Investing in mutual funds has become increasingly popular over time due to their manifold benefits like diversification, access to professional management, affordable investment option,s and high liquidity. However, selecting the right mutual fund is an arduous task for both beginning investors and seasoned pros alike. It’s been often seen that investors ask “how to choose mutual funds?” Understanding how different factors play a significant role in defining the performance of a mutual fund investment is crucial in aiding your decision. Let’s delve into the essential steps you need to consider when choosing mutual funds.
How to Choose The Best Mutual Fund?
As an investor, it’s crucial to comprehend how SIP works. SIP, or Systematic Investment Plan, is a method of investing a fixed sum, regularly, in a mutual fund scheme. The investor can choose the amount and the mutual fund scheme and contribute to it every month. How SIP works is pivotal as it harnesses the power of compound interest and rupee cost averaging, lowering the effects of market volatility. It helps instigate financial discipline and allows an individual to start investing with a small amount monthly. Understanding how SIPs work facilitates in making an informed decision about which mutual fund to choose.
Financial Goals
The primary step to choose mutual funds is to define your financial goals. Are you saving for a down-payment on a house, long-term retirement funding, or your child’s education? The length of time you plan to invest plays a significant role because, for shorter periods, it’s prudent to invest in anyone with low risks like debt mutual funds, whereas, for longer periods, equity mutual funds may prove to be beneficial due to their high return potential. Knowing how SIP works can help you decide how much you need to invest monthly to reach your goal considering the average annual return of the mutual fun.
Risk Tolerance
The second step in how to choose mutual funds is to determine your risk tolerance. Familiarizing yourself with the kind of potential losses you are willing to bear if the market plunges will help in calibrating how much risk you should expose your investments to. Naturally, higher potential returns come with the acceptance of higher volatility and risks. Hence, your asset allocation in the form of diversification across asset classes or sectors needs to be carefully evaluated and adjusted according to your risk appetite.
Past Performance
Reviewed past performance is the third step while selecting a mutual fund. While it’s important to note that historical performance would not guarantee future returns. A consistent record of performance over a period of five to ten years, under different market conditions, speaks volumes about the management’s ability to navigate rough patches. The mutual fund’s performance should be compared against its benchmark and its peers within the same category to ascertain its relative performance.
Fees and Costs
The fourth step on the path to choosing the right mutual fund is to evaluate fees and costs associated with the mutual fund scheme. Every mutual fund levies charges like management fees or administrative charges called expense ratio. Higher expense ratios can drastically reduce your returns in the long run. Investors need to compare expense ratios of similar funds before making the investment decision.
Right Fund Manager
Lastly, reviewing the fund manager’s credibility and experience is of paramount importance in your decision-making process. A good fund manager can pivot a mutual fund successfully even in a turbulent market. Look for a manager who has a consistent, proven track record and is transparent about their investment strategy and approach.
Selecting the best mutual fund can seem like an intimidating exercise. However, these five steps – understanding your financial goals, gauging your risk tolerance, reviewing past performance, evaluating the expense ratio and scrutinizing the fund manager can simplify the process remarkably. With a clearer vision about how to choose mutual funds and how SIP works, the journey of creating wealth through mutual fund investments can be truly rewarding.
