Basic rule for Mutual Fund investing

Mutual funds are a fairly simple way to make investments. It is less time consuming and simpler when compared to stock investment. Perhaps the only challenge is to choose the right fund. In fact even this is not difficult either. It only requires discipline and a little bit of time for choosing the fund. So give yourself a little time, follow the simple rules stated below, and attain your financial goals.

Understanding self: The very first basic step to achieving your goal is to know about oneself. Understand the most important aspect of oneself - risk tolerance. For this do a tolerance test.

If your Rs 10,000 investment turns to Rs 6,000 and this upsets you to the extent that without understanding why it happened or how has its peers performed etc, you would withdraw your investments; then definitely any aggressive equity fund is not meant for you.

Being realistic: What are your goals?

If you need to turn Rs 10,000 into Rs 50,000 in two years, well the risk in such a case would be that you could lose a lot of the Rs 10,000 or perhaps the entire sum or reach your goal.

But if you plan to see your investment rise from Rs 10,000 to nearly Rs 15,000 in two years which essentially means achieving a growth rate of 22%, though possible, it cannot be achieved by investing in bond funds.

This makes it essential that setting realistic expectations for both your goals and your funds is necessary.

To know what you are purchasing: Now that you have discovered yourself, spend some time for an understanding of the fund type that will best suite your needs. Check up the stated objective of the fund as given in a prospectus. Then check the available portfolio and fund manager's commentary, you can broadly understand the style and strategy followed by a fund with these two. This will help you understand the fund you are buying, and then in the process help to plan your portfolio in a better way. It will also help you assess potential risks in a better way.

Examine sector leanings: It is common knowledge that you should never put all the eggs in one basket. In the same way, funds with large stakes in just one or two sectors will be more volatile than diversified funds.

This is where looking at a fund's sectoral history will help you gain a good perspective. Does the manager move in and out of sectors frequently and dramatically? If so, the fund might get hurt, if the manager is ever caught on the wrong foot.

What is the fund's concentration level: A portfolio with just 20 or 30 stocks or one that puts most of its assets in just a few stocks will likely be more volatile than a fund that's spread among hundreds of stocks. But there could be rewards of concentration. A concentrated portfolio will give higher returns. Therefore, it makes it important that you are comfortable with your fund manager's style.

Checking the performance: "Past performance is no indicator of future results." This statutory warning is compulsory in mutual fund documents, advertisements etc. given to an investor.

And you should remind yourself of this sentence -- Past performance is no indicator of future results -- every time you plan to invest in any fund with a 100 per cent three-month gain. Why? Because everyone knows that few months of boom is followed by bust, as it has happened in 2000 and in recent memory in 2008.

So, what should you do? Simple, do not concentrate your mutual fund portfolio, or invest in a concentrated fund, or allow your portfolio to be concentrated. And, above all, don't focus on short-term returns. When choosing a fund, look for a funds previous performance during both bull and bear run i.e. good and bad times.

Know about your portfolio: Review your portfolio for concentration level once in a year or once in six months. If you like to see your portfolio quite often then once a quarter. Find out which segment over-represents and for those that are missing. For example, will your portfolio be overly concentrated in the specific sector or capitalization? Are you missing a particular sector or capitalization?

Be a disciplined investor: All successful investors are connected by one common string, they are disciplined. Over time it pays off. Once you have chosen some funds, monitor them and their fund managers and accordingly stick with them.

Follow these simple steps and there is no way that you will not make it to your goal.

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