Choosing a mutual fund can be challenging due to the abundance of options available. With over 40 AMCs, over 1000 funds, and over 2000 schemes, you have a lot to choose from. Here are 10 steps to pick a winning mutual fund and create a winning mutual fund portfolio. Rather than call it the 10 tips to pick truly solid mutual funds in your portfolio, we’ll call it the 10 tips to pick really solid mutual funds.
10 Tips on How to Best Choose Mutual Funds for Your Portfolio:
Tip 1 -
The performance of good funds has historically been attractive. In most cases, good funds have outperformed in most market conditions. However, any mutual fund in its risk factors will tell you that past performance is no guarantee of future performance. Long-term, at least, they outperform.
Tip 2 -
There is also a need to consider consistency of returns, not just returns. Consistency is quite simple to define. A fund that generates a CAGR of 13%, 14% and 15% over 3 years has given the same CAGR returns as another fund that generates 5%, -4% and 47%. There is no doubt in my mind that the first fund is significantly more consistent. Consistent funds tend to be more predictable.
Tip 3 -
A mutual fund’s fit into your long-term financial plan is also an important factor in its selection. Funds must be suitable for you in terms of returns, risk, liquidity, and tax efficiency. The best funds are useless if they don’t help you achieve your goals. Because of this, fund selection is very individualistic.
Tip 4 -
If you earn 15% returns in an equity fund, you need to ask what risks have been assumed. In terms of risk adjusted returns, the first fund is much better than one that gives 16% returns with 40% volatility. It is better to earn 14% returns with 10% volatility. Sharpe and Treynor ratios can be used to plot risk adjusted returns.
Tip 5 -
It is important to look at a fund’s consistency over time. Investing in a fund that sees a lot of churn among senior personnel, such as CEOs, CIOs, fund managers, etc., is not good for long-term performance and consistency in investment policy. It is ideal for funds to have a top management team that has been around for a long time. This provides more continuity.
Tip 6 -
It is better to invest in a fund that is based on processes and rules than one that relies entirely on the fund manager’s discretion. After all, the fund manager is human and is therefore susceptible to error. In the event the fund manager has full flexibility on everything, including dynamic asset allocation, then you are leaving too much at his or her mercy. That is not a good idea.
Tip 7 -
A 1% reduction in costs every year can make a significant difference in your returns over a long period of time. Remember that TER is debited to your NAV every day, so lower costs mean higher returns. Equity funds will, of course, have higher TERs than debt funds, which themselves will have higher TERs than liquid funds. Within a category, look for funds whose AUM is higher because the impact on your NAV will be lower.
Tip 8 -
The concept of “Invest and forget” is not in your interest. You should monitor your funds on a regular basis. You can gain a lot of insight from the fund fact sheet each month when you read the fund manager commentary, the actual returns, the variance in returns, the portfolio mix, etc.
Tip 9 -
Consider the exit costs before taking the exit decision. For example, occasional underperformance is normal, but if exit loads plus taxes plus liquidity costs are too high, the basic purpose is defeated.
Tip 10 -
The most important step in picking the best mutual funds is to focus on getting mutual funds that fit into your needs. Once that is done, the second step is to evaluate alternate options. You need to create a mutual fund portfolio that has the right mix of equity funds, debt funds, liquid funds, variable funds etc. You need to adjust this mix consistently based on the external and internal stimuli.
