You must have heard that mutual funds are a safe sideline source of income one can consider for less risky money growth.
This concept however is not only achieved by just entering into the mutual fund market but needs alot more attention at the time of choosing the best gains funds.
Even after good prospects and apple berry fuzz about any particular fund asset, the advertisement still ends with “mutual funds are subject to market risk, please read scheme related documents carefully”.
This is why we are here, before entering into the market, you need to ensure whether your principal amount can bear risk or not, and what is your aim to achieve via mutual fund investment.
Ensuring proper knowledge about the market and the individual fund will help you to align your investment objectives with the scheme and choose the best possible outcome for yourself.
Here are a few things you should always check for while choosing a mutual fund investment scheme:-
- Goals – The most important and the first step is to clarify your investment objectives. This includes short term, long term, investment capacity, whether you want liquidity or one time gains. mutual fund.
How much do you want to multiply your money, and how much savings expenses and investment can go hand in hand for your pocket.
The clarity in investment plans is crucial as this is what determines the further selection process of ideal mutual fund investment.
An investor knowing his needs and pocket would probably be able to align his goals with the market movements and enjoy gains.
- Expense ratio – Expense ratio simply means the expense incurred by the mutual fund scheme on its operations and management services.
This is calculated by the formula total amount of fund expense / total asset value of the fund. This is an important ratio to drive investor decisions.
It plays role in determining the net profitability. Less the expenses less the reduction from profits.
Let us use an example to understand how a small deviation in expense ratio can dilute the net profitability of your investment –
Suppose you have invested ₹ 1,00,000 in the ABC mutual fund scheme which proposes returns of 10%. When the expense ratio is taken to be at 2% the net gain you get is ₹ 10,000 – ₹ 2000 = ₹ 8,000. In another scenario, if the expense ratio is 3% then the net gain you get is ₹ 10,000 – ₹ 3000 = ₹ 7000.
This is how profitability changes with a change in expense ratio and therefore you should look for low expense ratio mutual funds. This can cost you a long way in compounding depending on the expense ratio.
- Exit load – Exit load is a deductible percentage of the amount from your total value of mutual fund asset if you wish to exit the scheme fully or partially before a certain specified time frame starting from the date when you acquired the investment.
The ideology behind the exit load imposition is to discourage investors to withdraw and protect the interest of investors who choose to stay. Whether to keep an exit load or not depends on the financial calculation of fund managers.
The calculation of exit load is done via the formula = percentage of exit load x number of units x net asset value.
Let us take a numerical example for simplification, suppose the exit load of the scheme is 1% if withdrawal is before 12 months, and the net value asset after 3 months is ₹ 500. Now if you want to withdraw 100 units from your portfolio, the exit load that will be deducted from proceeds is 1% x100 x ₹ 500 = ₹ 500.
It is an important indicator for investors who are visioned with short term goals and prefer liquidity. More the exit load, more the deduction or say losses while withdrawing and therefore erodes some parts of gains.
- Taxation rules – How can one be very happy if a major chunk of his gains is eroded by taxes? No right, therefore assessing and comparing mutual fund schemes with different taxation rules is important.
Not only just the tax regime but also the tax deductibility can be a major saviour of your prospective gains. Tax adjustment depends on the assets under the basket and the type of portfolio of the mutual fund scheme.
Generally, the dividend yields are added to taxable income and then respective tax slabs work upon them. But in the case of other windfall gains, taxation depends on the type of fund scheme.
For example, in India, equity mutual funds are taxable according to the time period of holdings. Long term capital gains are tax rated at 10% above the exemption limit of ₹1,00,000. Short term capital gains are valued at a tax rate of 15%.
Here the investor has alot to decide about tax benefits.
- Active or passive fund – Active or passive mutual funds are categorised based on how the fund managers deal with changes in the market.
Basically how actively the fund is being managed with time to time adjustments in portfolios determines the activeness of the fund.
Some examples where funds are actively managed are equity mutual funds, debt mutual funds, hybrid mutual funds etc. whereas passive funds are those having index portfolios or precisely exchange-traded funds.
You might also take the expense ratio in hand when choosing between active and passive schemes, as the expense ratio is higher in active plans than that of passive mutual fund schemes.
Choosing which one to enter depends entirely on what type of investor you are.
- Risk and Returns – The most important part that you look for is risk and returns. It is not a foreign relationship, risk and returns go hand in hand.
Riskier and more volatile the prospects get more the probability of high returns. Risk can be determined via market analysis and returns can be determined via your goals of investment and position of schemes.
A person with a high-risk appetite might prefer equity mutual funds whereas a person with a low-risk appetite with expectations of a certain level of returns might go for debt funds or safer options. Nowadays market analysts show up collectively and vote over the risk cycle for any specific mutual fund scheme and consider it as a risk meter.
- Method of investing – Investing method includes the way of entering the market via systematic investment plan, lump-sum investment, direct plans, growth plans, etc.
These decisions impact the level of initial investment amount and return over the period of time.
Not all mutual fund schemes allow systematically investment plans or growth plans.
Depending upon your time, investment objective and initial amount one can choose the best-suited plans after considering all methods of entering the schemes.
One must check for all the above-mentioned points beforehand to safeguard the deductions and maximise the growth of initial investments under mutual fund asset investments.
Ignoring sentiments of risks, returns, expenses and other factors might lead to false projections and can cost you high pennies on profit.
