New Year is a time for resolutions, learning from past mistakes and starting something afresh. It is also a time for introspection and taking stock of hits and misses from the past year’s targets on personal, professional and financial front. If one of your financial resolutions this year is to start investing in mutual funds, you have certainly made the right decision when it comes to growing wealth. But how does one begin? How to select a mutual fund that would be congruent with your financial objectives? Here are a few things to look for while making your selection.
When you invest in a mutual fund, your goal in terms of target date, time-frame and return expectations should be the starting point. In the absence of a clearly-defined goal, you might be tempted to stop, exit or forget about your investment.
A goal can be short term like purchasing utility goods, down payment for a house or international holiday or long term like retirement or providing for college education of children. You can separate out your short-term goals and long-term goals and then select the right funds based on the time horizon to take a call.
‘Risk comes from not knowing what you are getting into’. Before choosing a mutual fund, the investor should analyze the risk associated with the investment and if it aligns with the investor’s own risk profile.
Equity mutual fund investments are subject to volatility and thus the portfolio might see ups and downs in the short term, although the returns can be substantially higher than other types of funds. These might be suitable for aggressive investors with reasonably long time-frame.
Debt mutual funds, on the other hand, are more stable, but give lower returns than equity funds. These might be suitable for conservative investors. You can follow the table below to understand the category you fall into based on the time horizon and your risk profile, to select the appropriate mutual fund for yourself.
Primarily, an investor should be able to ascertain as to when is the invested corpus needed.
If the money is needed in the near future, it should not be invested in equity mutual funds.
The money that can be put aside for a reasonably long period of time without worrying much about the market ups and downs should only be committed towards equity mutual funds.This is also important because compounding works best when money is left untouched for long periods of time. Hence, if you want to raise money for a short period, go for liquid funds.
Fund performance matters, but not from a short term perspective of 6 – 12 months or even one or two years. It should be considered for a reasonable time-frame. This is to ensure that the fund investments have gone through multiple market cycles and the returns have been consistent. In case the fund has not been able to beat its benchmark over three, five, seven or ten years, it is reasonable to believe that the fund might not be a good investment in the future as well. While evaluating a fund’s performance, it is important to check the performance details of the Fund Manager or the Fund Management team. A strong, stable, experienced fund management team with a reasonable tenure and proven track record would prove beneficial for investors.
Go For Direct Plans
There are two types of plans available for a mutual fund scheme-direct and regular. Direct and Regular Mutual Funds are different versions of the same plan, wherein investors can directly buy required NAV units from a concerned asset management company in the first case, while the units have to be purchased through a commissioner or broker in case of the latter. A key difference between direct mutual funds and regular funds is that higher returns are usually generated in a direct mutual fund as no expenses are incurred as brokerage fees. This commission varies between 1 and 1.25%, depending upon the asset management company and brokerage firm.
In case of regular mutual funds, the concerned Asset Management Company (AMC) pays commission to the brokerage firm for increasing their clientele. This reduces the principal amount of investment, thereby reducing total returns generated. Needless to say, when we compare the expense ratios of direct mutual funds with that of regular funds, it is lower in case of the former as direct mutual funds do not have associated costs of brokerage. Earlier when mutual funds were just introduced in India, going the regular route made sense due to lack of educational resources around the subject.
However, now there are many platforms that offer you the necessary resources to take investment decisions by yourself and hence you need not be dependent on agents for advice and lose money on commissions.
Tax consideration is an aspect investors should look into carefully before investing in a mutual fund. As an investment vehicle, mutual funds are quite efficient in terms of post-tax returns. When equity fund units are redeemed, the returns so generated are taxed according to the period of holding and the applicable tax rate.
- For equity funds, Long Term Capital Gains (holding period of 12 months and above) are taxed at 10% over and above the exemption limit of Rs 1 lakh.
- Short Term Capital Gains (holding period of less than 12 months) are taxed at 15%.
- For debt funds, indexation benefit is available for capital gains realized.
(For these funds, a holding period of 36 months or more is considered as long term. Any holding period which is less than 36 months is treated as short term and the gains are added to the income of investors for tax calculation). So, take the tax aspects of the fund category you are looking to invest in before you take a call.
To Sum Up
Investing and long-term wealth creation require patience and discipline. What it also requires is for you to do your research and know fully well about what you are getting into. So, make informed decisions based on your requirements rather than recommendations and peer pressure. Ensure your choice of fund aligns with your investment objectives and keep reviewing your portfolio post investment to track the performance of your funds
Main Source - Financialexpress