5 factors to consider before investing in any Mutual Funds

Mutual funds investment for long-term is considered one of the best ways to accumulate wealth at a rate that can beat growth in inflation. However, there are some important factors that an investor must look at while choosing a mutual fund plan.

1. Time Horizon

Before choosing a mutual fund, the first step is to decide the goal – the time frame you are looking to invest for, return expectations, etc., since these will help you choose a fund that is best suited to your requirements. However, even in the case of the absence of a clear goal, one doesn’t need to cut short their journey.

Speaking on the importance of time horizon while selecting a mutual fund plan, SEBI registered tax and investment expert Jitendra Solanki said that one should be clear about for how much time he or she would invest in the mutual fund plan he or she is looking at. On the basis of that one should decided the category of fund. For example, if an investor is looking for long-term, then a small-cap fund can be a good option whereas investing for medium term, mixed-cap or mid-cap funds would be a better option.

2. Expense ratio

The expense ratio is the commission charged for the proper management of investments. As an investor, it’s important to seek a mutual fund that comes with a lower expense ratio since the expense ratio is calculated across the investor’s total portfolio and will have a significant impact. It’s often said that the higher the AUM, the lower the expense ratio.

Equity funds have an expense ratio of 1.5-2% while index funds have much lower expense ratios. Compare the returns of the fund vis-à-vis the expense ratios.

3. Exit load and Tax implications

These are broadly applicable to all the funds you choose but it important to understand the implications of these. For example, if you sell equity funds before a period of 1 year they attract STCG tax at 15% while debt funds sold before 3 years will attract STCG tax of 30% (peak rate). Similarly, equity funds LTCG gains were tax-free but from April 01st 2018 any gains in excess of Rs.1 lakh will be taxed at a flat rate of 10% without the benefit of indexation. Also look at the exit loads applicable which may range from 0.5% for larger funds to 1% for smaller funds. They make a difference to your return on investment.

4. Risk Analysis

We all know that the past is not an index of the future but when it comes to mutual funds consistency of past performance matters a lot. 15% return with low volatility is more preferable and attractive compared to 17% returns with high volatility. You need funds that outperform the index funds over a longer period of time otherwise you are better off staying invested in passive funds like index funds and ETFs. More importantly, also look at returns in risk adjusted terms. That is where the Sharpe and Treynor ratio come in. 16% return with acceptable risk is better than 19% return with high risk.

5. Investment Curve

This is a qualitative judgement but you need to do this analysis before investing in a fund. Has the equity fund manager managed to move into winners early and move out of losers early? Your fund manager may not catch every trend in the market but as long as he catches the key trends it is good. In case of a debt fund, has your fund manager been able to tweak the maturity of the portfolio based on interest rate expectations. In case of hybrid funds, has your fund manager handled the mix of equity and debt smartly? The bottom-line is that the fund management should be ahead of the curve; that is what differentiates a good fund manager from an average fund manager.