Mutual Funds come in all flavors. If you are not clear on what you want you will only end in confusion. The marketing agents will overwhelm you will jargons and power sell you the funds that offer them the maximum commission. So where are you in this equation? The ten easy steps for a prudent investor are as follows :
1. Know your investment objective
2. Decide on the fund type
3. Fund Managers past records
4. Is the fund actively managed
5. Post tax performance as compared to its benchmark
6. Investment concentration
7. Volatility of NAV
8. Expense ratio
9. Change in style or performance
10. Future prospects
Now let us look into the steps in greater detail .
1 . Know your investment objective:You need to answer the following 4 questions to understand your investment needs. These questions applies across asset class and is applicable for all investments.
2. Decide on the fund type : Funds comes in all shapes and sizes . The broad categories are debt funds, equity funds, money market funds, index funds , funds focused on sectors ( say only equity of pharmaceutical companies ) .
As explained it will depend on the overall investment objective of the investor and his risk appetite that will help him to decide on the fund type. For example if you have a well-diversified equity portfolio but lack exposure to pharmaceutical companies you may buy a mutual fund focused on that sector.
3. Fund Managers past records: How has the fund manages fared in the past. How long has they been with the fund. Is there frequent change of fund managers for the fund.
4. Is the fund actively managed: Is this an index fund or an actively managed funds. Index funds as the name suggests tracks the performance of a particular benchmark index. The expense ratio of index funds should be lower than the actively managed funds.
5. Post tax performance as compared to its benchmark: What’s the return generated by the funds as compared to other comparable investments on a post-tax basis? On a post-tax basis are you being compensated for the addition risk taken?
6. Investment concentration: Look into the top holdings of the fund. Are they in line with the stated objectives? Do you see in over concentration in any sector? Higher concentration may translate to higher risk. For example a fund concentrated in commodity sector would have underperformed the index in the past six months. On the other hand a FMCG fund would have done better.
7. Volatility of NAV: There are different measures of volatility. We will go into more details on volatility and risk measurement in our future articles. But for now its good enough to know
Higher volatility = higher risk
Look at the SD of the fund NAV. Higher the SD higher the risk for similar funds
8. Expense ratio: This is something the distributors will tell you to ignore. But please don’t. This is composed of the entry load, exit load and operating expenses. Expense ratio is what that makes the difference between returns of similar funds. As the expenses are charged every year the compounding effect is substantial.
9. Change in style or performance & Future prospects: As always stated in the disclaimers past is no prediction of the future. Nothing is truer than this. Understand the fund style. Is there any change in the holding pattern for the fund? Is there too much of churning in the recent past?
How are sectors / companies where the fund has major concentrated holdings expected to perform.
It’s your hard earned money. Manage your investments actively and seek professional help if need be.
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