How to choose a mutual fund?

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How to choose a mutual fund?
There are many thousands of funds. And all claim to be unique and everyone would make a different suggestion. This make the task of choosing a mutual fund very difficult.

So even though you know the 'Basic rule for Mutual Fund Investing', you find it difficult to choose a single fund. To release of your hassles in thinking on how to choose we have prepared the simple check-list that you must look at, when choosing a good fund.

  1. Performance
  2. Risk
  3. Management
  4. Cost

Performance: You cannot compare an apple to an orange, even though they are both fruits. Similarly performance comparisons can only be made between same type of funds. You cannot compare an equity fund with a debt fund or an income fund with a growth fund.

They become meaningless. Only when used within the same category of funds will performance numbers be meaningful. (Read about the different types of funds)

Risk: Investment by their very nature carry risks of one or the other kind. And it is common knowledge that if you increase the risk, the chances for your returns will also be high. This assumption is not correct, since it leads to think that risk is proportionately related to returns. This is not true since no similar fund is run in the same fashion.

This can be checked by looking at the return and comparing it to the risk that was taken to produce it. A lot of time you will hear people of talking about risk-adjusted returns. Well they are looking at the returns in the light of the risks.

But this many not be easy for you to look at. So the more handy and practical way would be to compare the returns of funds from the same category during bull and bear run. Or compare the fund's return to its benchmark during the bull and bear runs.

Management: Something very essential to understand here is that certain types of funds like shorter-term, income funds, index funds do not depend up on the manager. By far and large everyone in this category produce similar results.

But fund management is an important factor in an equity fund. Different fund managers will buy different set of stocks and yet in their performance all of them would be the leaders of their category. This is why equity investment is considered more of an art than a science. So investing in a fund is basically about trusting in a fund manager's individual style. Therefore, before investing with a fund, look at its fund manager, because if a new fund manager is at the helm of a high-performance equity then it is a very much like a new fund.

Cost: The last point here would be the increasingly important factor, i.e. cost. Mutual Funds are not charities or non-profit organizations. They are run by organizations to produce profit and cover the expenses, the total of which is put up as a fees. Though funds in the same category do not have huge difference in their costs. But if this difference is compounded over a period of time then it will be a considerable investment.

Armed with these four basic considerations, you will get to choose the best of funds.

OneIndia Money

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