Tips to choose the right mutual fund

Saving and investing for future financial security is a top priority for every individual. For many of us, increasingly busy lifestyle and lack of knowledge prove to be a hindrance in choosing the right investment product. Mutual funds offer professional investment management for such individuals at an affordable cost. However, it is important that we analyze the following factors before choosing a mutual fund investment.

1. Goal associated with the investment: We make investments to ensure that our savings enhance our ability to reach our goals. The investment should be in sync with the tenure of the goal. If you have a short tenure, picking debt funds is a good option. For investors with medium tenure, balance funds which have exposure to both debt and equity are a good option. Long term investors can opt for more exposure to equity.
2. Know where your money is being invested: Mutual funds pool investors' money to make investments across different securities as per a predefined investment strategy. A mutual fund in itself is a portfolio managed by professionals on behalf of the subscribed individuals. It is an advisable practice for investors to understand the investment objective of the mutual fund and know the securities in which the investment will be made. Investors should also know the stated benchmark of the mutual fund. This can help them compare the performance of the selected fund among the peers. This will also provide insights on the expected return and corresponding risk of the investment.
3. Risk and return associated with the investment: Risk and return are an integral part of every investment. Balancing these factors would help individuals maximize their returns by taking calculated risks. In order to do so, it is important that the individuals analyze their risk tolerance. Risk tolerance in simple terms can be stated as the willingness of the individual to accept the price swings of investment. Ideally, the risk tolerance/risk appetite of the individual should be in sync with the risk-return tradeoff of the mutual fund. Diversification also helps them arrive at a suitable risk-return tradeoff. Based on the past performance of the fund, investors can gauge the mean return and risk associated with it.
4. Mutual fund fees, charges and net return: In lieu of services provided, mutual fund houses charge a fee on the investments. The fees are classified as exit load and expense ratio. These fees have a major say in determining the net return on the investment. Mutual funds charge an exit load on investments which are redeemed before a stipulated timeframe. Before investing in mutual funds, investors should know the time frame till which exit load is charged. This time frame should be less than the time frame of goal for which the investment is being made.
   
   Expense ratio is the recurring fee charged by asset management companies for managing the investments. The expense ratio varies from 0.5 per cent to 2.5 per cent based on the nature of the fund and investment style. Since the expenses are deducted from the earnings of the fund, it lowers the effective return of an investment. For example, if a mutual fund has a stated return of 10 per cent and an expense ratio of 2.25 per cent, the net return of the investment is 7.75 per cent. With all factors equal, it is advisable to opt for mutual funds with lower expense ratio.

ArthaYantra.com provides personal financial advice online.

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