How to choose mutual funds?

The olden days of earning and saving up to accomplish long term and short term goals are gone. Nowadays, people don’t just want to save their hard-earned money but to make it grow like a plant. In order to accumulate wealth to fulfil their goals, people have turned to mutual funds investment, by far one of the most popular forms of investment for the common man. But once you decide to invest in mutual funds, you are faced with the arduous task of choosing from hundreds of different mutual fund types. How does a beginner in investment choose one or two mutual funds from so many different types?

If you are such a person, then do not worry. Through this guide, we’ll help you choose the just the right type of mutual fund that will be suitable for you. Read on to know more about how to choose mutual funds in India.

When it comes to mutual funds, new investors always ask the same question: ‘Which is the best mutual fund to invest in?’. In short, they put the onus of investment entirely on the fund itself. But, the problem with this approach is that all mutual funds are not completely suitable for each and every type of person. Therefore, the right question should be: ‘Why am I investing and what do I need from this investment?’. It immediately puts things in perspective as now you have a goal or goals in mind that you want to fulfil using your investment.

Investment goals can be:

• Buy a car or a house

• Go on a foreign vacation

• Prepare for children’s education expenses

• Prepare funds for retirement

• Prepare for children’s marriage

Think about how long you want to remain invested.

Now that you have your goal in mind, you can easily find out whether that goal has to be achieved within a few years or after a longer duration of time. Buying a car or a house can be a short term goal while preparing for retirement is a long term goal. The reason this matters is because for shorter term goals, the risk that you should take in mutual funds should be as low as possible. However, for longer term goals, you can take more risks because mutual funds almost always give healthier returns the longer you remain invested.

A factor while considering mutual funds is to find out whether your goal is negotiable or not? Your home loan payment and your children’s education or marriage are non-negotiable goals that you must fulfil at any cost because these cannot be postponed. On the other hand, planning a vacation or buying a car are negotiable goals that you can postpone if you do not have adequate funds.

It is vital because a non-negotiable goal requires an investment that has stable returns and low risk as you will not be missing out on fulfilling that goal.

Now that you know what your goal is, whether it is negotiable or non-negotiable, and how long you have before you can fulfil it, you can choose your mutual fund by combining these factors.

To understand the above table, we must first understand that debt funds have the lowest risks, equity funds have higher risks while balanced funds are a combination of the two.

Example A

You want to invest and accumulate funds for your 8-year-old child’s college education. Now you know that a college education is a non-negotiable goal, and since your child will require a college education at roughly 18 years of age, you have a full ten years to accumulate those funds. It makes it a long term goal. For non-negotiable, long term goals, mutual funds investing in equity will be your best bet, since they will generate high returns in the longer run.

Example B

You want to start saving for your son or daughter’s marriage, which you have planned in the next 2-3 years. It again is a non-negotiable goal, but with a shorter term. In this case, your best bet would be to invest in debt-oriented mutual funds because they will give stable returns in 2-3 years with less volatility as opposed to equity funds.

Thus, with an approach that first makes you ask questions to yourself, you can easily narrow down the options that you have for investing in mutual funds. It is always best not to look for the ‘best’ mutual fund even before you have decided what exactly your aim is. To find out how to select best mutual fund, you have to decide what your goal is.