How to select which mutual fund to buy…

It has now been amply proven that mutual funds provide a unique vehicle to build wealth over a longer period of time without the hassles of direct management and with the benefits of diversification. With very low entry barriers, almost anybody can start off a systematic investment plan (SIP) on mutual funds and get the benefits of wealth creation over a longer period of time. But the key question is how to select a mutual fund and how to narrow down on the style of fund.

Big fund house versus small fund house…

This is a standard debate most retail investors have. Should they go for an established name backed by large financial institutions or for smaller funds that can generate better returns because they are fleet-footed? Frankly, this should not be given too much importance. What matters is the performance of the fund, its commitment to the business and the track record of the fund manager. Smaller funds at times do manage a better performance due to their smaller size, but we have seen in the past that many smaller funds have got merged out with larger names. Narrow down to a handful of well-performing established fund houses and take your pick from that.

Equity versus debt funds…

That is not exactly a discrete choice. Both are a necessary part of your portfolio and both make a lot of sense at different points of time. You obviously cannot have all your money in equity funds and hence you need to allocate some portion to the safety and regularity of debt funds. Then there is an opportunistic call that you need to take. When index valuations are at an all time low, ensure that you are substantially invested in equity funds. On the contrary, if you expect interest rates to fall, then ensure that you increase your allocation to debt funds to make the best of the bond appreciation story.

Passive versus active funds…

A passive fund like an index fund simply mirrors the index value and does not do any stock picking. Globally, indexing is big business as the outperformance by active funds is not too pronounced. India, however, is a different ball game. There are plethoras of small and mid cap companies that can give super-normal returns if identified and capitalized at the right time. These can only be done by an astute fund manager with an eye for spotting these opportunities. You can surely have a small allocation to index fund to play the passive game. Ensure that you allocate a larger portion of your equity fund investment to active funds so that you make the best of the mid cap stories in the Indian context.

Sector funds versus diversified funds…

Sector funds or theme funds tend to be very focused on a particular theme or industry. They normally are visible at the peak of frenzy in the markets. For example, back in 2000 we saw a host of technology funds in the market. Similarly, in 2007 we saw a large number of infrastructure funds coming into the market. There are two things investors need to remember about sector or theme funds. Firstly, while they can outperform while the euphoria lasts, they can also sorely underperform when the tide turns against them and may continue to quote below par even after many years. Secondly, investors need to remember that one of the core ideas of investing in mutual funds is to get the benefits of diversification. A sector fund which concentrates risk is against the basic grain of diversification. To the extent possible, long term investors should stick to diversified mutual funds within the equity space.

Should I invest now or after a correction?

This is a standard question investors ask before investing in mutual funds. Remember, the moment you ask this question, you are trying to time the market. That is not a great idea. You buy mutual funds to create wealth over the long term without the hassles of day-to-day money management. The empirical reality is that over the longer term your timing of entry hardly matters and makes little difference to the overall return. So why worry about timing your entry. Take a regular SIP approach to investing in mutual funds. Rely on the power of time, not on the power of timing.

Lastly, remember that mutual fund investing is not a stand-alone process and it should fit into your overall financial planning objectives. It would therefore be best to consult your financial advisor and build these mutual funds into your overall plan, so that your goals and resources are clearly identified.

For all your mutual fund queries SMS ‘ASKMF‘ to 575758 and we will get back to you.

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