Technical Factors to consider during the mutual fund selection
Picking the right type of mutual fund scheme might allow the investor to earn a desirable corpus over the long term. As more and more people have started to realize the potential of mutual funds, this investment vehicle witnesses new investors every month. Also, there are a lot of educational initiatives about investment which the government has taken up, thus busting a lot of myths surrounding these market linked schemes. Yes, it is true that mutual funds do not guarantee returns. But what is also true is that as per historical data, mutual funds have outperformed all traditional investment avenues by generating double digit returns.
So, if you too are planning on investing in mutual funds to target your life’s short or long term financial goals, you should ensure that you make an informed investment decision. Here are a few technical factors that all investors should consider while ensuring that they choose the right type of mutual fund scheme:
The expense ratio is important
One cannot stress anything more than a mutual fund scheme’s expense ratio. New investors end up investing in a mutual fund scheme based on its past performance, but they miss out on considering the scheme’s expense ratio. For those who aren’t aware, an expense ratio is a fee that is charged by the fund house for managing the mutual fund. It covers basic operational costs, administrative expenses as well as the fees of the fund manager managing the fund. Investing in a mutual fund with a high expense ratio can affect an investor’s long term capital gains. Do remember that direct mutual fund plans have a low expense ratio than regular mutual fund plans.
Is the portfolio diversified?
Remember that investors prefer mutual funds over stocks because they offer active risk management by investing in a diversified portfolio of stocks. This avoids concentration risk as the portfolio is well-diversified. Check for the companies in which the mutual fund invests to get a clear perspective on the risk profile of the fund. A well-diversified mutual fund has the potential to outperform its underlying benchmark over others. Because if a few stocks in that portfolio are underperforming, the other stocks in which the Fund invests can balance the overall returns thus allowing the overall mutual fund portfolio to deliver even when few of its underlying securities are not doing well.
Choose a fund that invests in credible securities
The securities in which a mutual fund (be it equity or debt) invests, all of having been given a certain rating by CRISIL, an analytics agency that determines a security’s attitude toward growth and risk. If a mutual fund that you are planning on investing in invests in AAA+ rated securities, then you may not have to worry much as the scheme only invests in top rated securities. However, in case the fund is investing in below AAA rate securities then its investment portfolio may carry a very high risk. Such mutual fund schemes may have a very risky portfolio, but they also have the potential to generate better returns than other schemes.
Understand the risks involved
Before investing in a mutual fund scheme, investors must the risks which the fund manager took to generate its past returns. This can be done using Standard Deviation and Beta.
Standard Deviation: The standard deviation method judges how much exposure the fund has had to volatility in the past three years. Fund with a low standard deviation should be avoided as they are extremely risky.
Beta: It is understood that funds with a high beta should be avoided as they are more volatile than funds with a low beta score.