While investing in mutual funds or while researching the ideal mutual funds to buy, chances are that you have gone through a checklist to make your choice. In most cases, even though the checklist might seem appropriate to base your decisions on, they are fraught with danger and can end up doing more harm than good to your portfolio. Some of the common misguided approaches that you could base your decisions on are:

1) Past performance: This is one of the most overused metric to identify funds that an investor would find appropriate for his/her portfolio. Purely looking at past performance is by no means an ideal barometer on which decisions can be made. It is more important to look at the performance of a fund under different economic conditions e.g.: under periods of high growth, high inflation, low markets etc. to understand if the funds have performed admirably under all conditions.

By allowing yourself to understand the performance of a fund under different stress conditions you will not only get a better understanding if the fund is performing as per the strategy defined by the fund manager but also form a more effective way of choosing and understanding your funds.

2) Size of the fund: There is a common misconception that larger the fund, the better its performance. However, nothing can be further than the truth! Large funds even though provide better liquidity might be less nimble than some of the smaller funds when it comes to buying and selling thus affecting their performance. Even though the size of the fund would help in achieving investor confidence, it is in no way a reflection of the performance of the fund in the future

3) Fund manager: Being aware of the track record of the fund manger is useful especially to observe if they have stuck to the true nature and strategy of the funds even under unfavorable conditions. However, making the choice of buying a mutual fund solely on the basis of the fund manager is not prudent. In this day and age of professional money management, fund houses groom a set of fund managers who are ready to take charge and follow pre-defined strategies if and when there is a departure of an existing fund manager.

4) Mutual Fund Rankings : There are several MF ranking research sites available nowadays and sometimes they end up confusing an investor rather than help them make better decisions. Buying a fund purely based on its rankings is like buying a car only based on its safety rating. It is important that an investor understands the methodology behind the ranking and why some of the funds are ranked higher than the rest. If you read closely even the MF ranking sites would caution you against buying a mutual fund purely based on its ranking. Think of it as a handy tool but not THE tool when it comes to making a decision.

5) Strategy: Picking funds only based on highly popular strategies can be harmful to your portfolio, for e.g.: buying only Equity Linked Savings Scheme (ELSS) since it provides tax benefits might not be particularly useful as it also comes with a 3-year lock in period that might not necessarily fit with your investment plan. Before you buy a fund, it should make strategic sense based on your risk-age profile to include different schemes in your portfolio.

All in all a holistic approach is required to invest in mutual funds as no single metric can fully capture the complexities and the true behavior of the fund.

Happy investing!

Author: The article is written by Sandip Southekal. He is the Co-Founder of TriVest Folio (www.trivestfolio.com) a personal investment tool to help build a diversified portfolio of Indian Mutual Funds and ETFs.