Shopping for a mutual fund can be hard — after all, there are literally thousands to choose from. However, by understanding your risk profile and investment goals, considering highly-rated funds, and evaluating past performance, you can narrow down the selection, and find mutual funds that are right for you. Here are five questions you need to ask before picking an equity fund:
1. How much should I invest in an Equity Fund?
Equities are a great way to beat inflation and generate long-term wealth. However, the stock market has its ups and downs, and the value of your equity mutual funds moves with the stock market. “If you’re in 20s to 40s, you have time on your side and should invest more in equities. But here’s a rule of thumb – if you can’t afford to lose any money at all – or if you’re not comfortable imagining a 20% loss in your equity investments, you shouldn’t be in equities,” says Kunal Bajaj, Founder & CEO, Clearfunds.com, a SEBI-registered online investment advisor.
2. Large-cap, Mid-cap, Small-cap or Flexi-cap?
Picking between these funds is a balance between risk and returns. Firstly, all equity funds are risky when held for the short term. Equity funds deliver exciting returns when held for the long term. Small and mid-cap funds carry the potential (not a guarantee) of higher returns over longer periods of time. Flexi-cap funds give the fund manager flexibility in his investing style (large-cap vs small-cap) and have historically delivered better returns over the last 20 years.
The largest chunk of your equity investment should be large-cap funds, with your mid-and small-cap investment based on your personal ability and willingness to take on risk, and volatility.
3. What are Fund Ratings?
Two of the most-frequently used methods of rating mutual funds are the Morningstar and Value Research ratings. “Both use a five-star scale to rate funds and base their ratings on the fund’s past performance, the manager’s skill level, risk- and cost-adjusted returns, and consistency of performance. Five stars is the best, but you should consider three and four-star funds as well. Remember that these ratings are based on the past performance, and are not necessarily a guarantee of the future performance,” informs Bajaj.
4. Growth or Dividend?
Many mutual funds choose to share their profits to shareholders in the form of dividends, while others choose to use their profits to reinvest in the growth of the company. You should select between growth or dividend options based on how often you need the money and your current tax rate.
5. Direct or Regular?
Whenever possible, pick a Direct plan. “Every mutual fund now comes in two flavours: Regular – where a regular commission is paid to your bank or advisor, out of your investments; and Direct – where no commission is paid to anyone. When you buy a Direct mutual fund, the commission saved is added to your wealth – which means more for you and your family, instead of your advisor’s. So whenever possible, pick the Direct plan,” says Bajaj.