Choice of a right mutual fund is not a unilateral decision. Selecting a mutual fund based on recent performance and solely on the basis of latest returns can be a big mistake. While there are top rated funds in each category, however, your portfolio shall be a reflection of carefully curated assets based on multiple factors like short-term goals, middle term goals and long-term goals.
Here is a list of 6 criteria of picking the right mutual fund.
The Expense ratio
Mutual funds incur certain operating expenses for managing a mutual fund scheme. These operating expenses involve advertising expenses, administrative expenses, transaction costs, investment management fees, registrar fees, custodian fees, audit fees as a percentage of the fund’s net assets.
This percentage cost is called “Expense Ratio” of the fund. For example, an expense ratio of 2% per annum means that each year 2% of the scheme’s total assets will be used to cover the expenses for managing and operating a scheme. The expense ratio incurred by a Mutual Fund AMC is managed within the limits specified under the SEBI mutual fund regulations.
Presently, for actively managed equity schemes, the total expense ratio (TER) allowed under the regulation is 2.5 % for the first Rs 100 crore of average weekly net assets; 2.25% for the next Rs 300 crore, 2% for the subsequent Rs 300 crores and 1.75% for the balance AUM.
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The net asset value of a mutual fund is directly affected by the expense ratio of a scheme. The lower the expense ratio of a scheme, the higher the NAV. A scheme with a higher expense ratio is better than one with a lower expense ratio, provided the scheme gives a decent return.
Taxation in mutual funds
Mutual funds are either equity oriented or debt oriented. The equity-oriented scheme means a fund where the investible funds are invested in equity shares of domestic companies to the extent of more than 65% of the total proceeds of the fund. Long-term capital gain is levied if the mutual fund is held for more than 12 months.
The Income Tax Act exempts the long-term capital gains from the equity-oriented fund (listed) to individuals, HUFs, companies and NRIs. However, if the period of holding of an equity-oriented fund is less than 12 months, then the short-term capital gain tax levied is 15%. Investing in unlisted equity-oriented mutual funds invites long-term capital gains at the rate of 20% with indexation benefits. Similarly, long-term capital gains in other than equity oriented funds invites taxation at 20 per cent with indexation benefits. The short-term capital gains in equity oriented fund are 15% and tax on other than Equity Oriented Fund is levied on the slab rate.
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Risk and return from the fund
The first thing one tries to find out is the nature of the fund to invest in. Equity mutual funds offer greater return with greater risk and debt mutual funds offer liquidity and are less volatile. The risk in debt fund is mainly interest and credit risk. However, the equity fund is governed by volatile macroeconomic factors.
There are 10 categories of equity mutual funds to choose from and 16 categories of debt mutual funds to opt for. The choice of the fund is related to the individual’s risk appetite, investment goals and the duration of the holding. The debt mutual funds are mainly a function of duration. There is an option before investors to invest for a day to more than 10 years. However, the categorisation in equity mutual funds depends on the stock sizes, sectoral preferences to investing beliefs. Investment in equity mutual funds is for long-term wealth generation.
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The philosophy of the mutual fund
There are different approaches to money. Some can be a value investor while some like to bet on the contrarian beliefs. Different philosophy entails opting for either a growing stock or grown and stable stocks. Some like to invest at a certain discount with a belief of leveraging on the discounts later. One important thing to figure out is to opt for a “growth” fund or dividend yield funds. Investing in the growth fund, one buys the best and fastest growing companies while some own blue-chip companies with a promise of dividend yields.
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Ratio and performance analysis
One needs to compare the risk and the performance by finding out average returns, Sharpe and tenor ratios and standard deviations. It measures the exposure of risk and the alpha created vis-a-vis risk and the average return. Alpha reveals the extra or less income generated in comparison to a benchmark. One can check how often a positive alpha has been generated by the fund managers in the last quarter and keep an eye on its consistency before scouting for an ideal fund.
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Fund managers are a bunch of professionals who manage a fund actively. A passive-managed fund is often cheaper as compared to an active-managed fund but, a rightly-managed fund ensures delivering the investor’s goal and aspiration. Before investing in a mutual fund, as a smart investor, one should know about the fund managers and their past track record. Exit a fund if the changed fund manager’s performance is not in conformity with your money goals.