As said in a famous saying “give a man a fish, and you will feed him for a day. Teach a man to fish, and you feed him for rest of his life”. Likewise in my view it is important to know how to select mutual funds rather than knowing about the best / top mutual fund names you can choose today. There are tons of free food available over the web (just Google for “Top 10 Mutual Funds to Invest“), but how do you know the value of the content? For that you should have to know the basics of picking the mutual funds and will you detailed step by step procedure that you need to follow for selecting mutual funds.
First things first, you have to be clear about your goals and the need for your investment and its better to have the clarity on the following things before you start the process.
Why Should You Invest?
The purpose of the investing should be known to you, investing just for the sake of saving may not for you. Please think and list down your goals, calculate how much you need to invest every month to reach your goal, how long you should invest and the expected returns (please be conservative in assuming the returns for equity mutual funds (you can assume a higher return between 15% to 20% while calculating your returns but you should also have to be prepared for 50% downfall (there are chances!) in the market just before or even worse in the year when you are expecting returns, So I would suggest you to be in pain now rather than being sorry in future. I would personally consider 12% as expected returns from my personal portfolio and would treat anything above that as a bonus.)
What is Your Risk Appetite?
Ask I have asked above check how comfortable can you be if you see 15-20% negative returns in your portfolio. Equity mutual funds will be aggressive in nature and likewise the returns will be. Although it is safe to assume that you will see returns in the range of 12% if you continuing for long term (read >10 years) but nothing is certain in life.
What Should be Your Asset Allocation?
Based on your risk appetite you can choose your asset allocation, general thumb rules practiced by financial blogger or advisers in the market is to be in equity for the percentage of 100 minus your current age, for example if your 30 years old your asset allocation should be 70% in equity class assets and 30% in debt assets. Choose the one you are comfortable with, after all it is PERSONAL finance and should be personalized.
How Many Funds Should You Invest in?
There is no thumb rule that tells us about the ideal number of funds you should have in your portfolio, for many even a single equity diversified mutual fund have worked well but if you ask me personally it is good to have minimum of 2 mutual funds from each category (equity / debt / hybrid / etc.).
Once you have settled with the answers for the questions asked above you can go ahead and start the process of choosing the Right Mutual Fund for you.
For the sake of simplicity I am going with ValueResearchOnline website for comparing the returns of mutual funds, you can feel free to use MorningStar, MoneyControl or any other website that you are comfortable with. The steps that you should follow should be same only that the options that you should select will vary as per the website that you choose.
Note: For the sake of an example I am considering “Equity – Multi Cap” fund category in this tutorial, please free to select the category of mutual fund of your choice to shortlist mutual funds.
Step 1: Go to ValueResearchOnline and navigate to Funds and select Fund Selector. Refer screenshot.
Step 2: As I am not obsessive with fund house I am leaving the fund house field unchecked, under fund category I am selecting “Equity – Multi Cap” (refer my note above) and finally in the field Exclude close-end, Plans Suspended for Sales, direct plans (I suggest you to go for direct plans, excluding this category to avoid duplicates and also there is no long history for direct mutual funds is available as they are introduced only on January 1, 2013.) and uncheck 3 star, 2 star, 1 star and unrated. Now click on GO.
Step 3: In the results page, click on returns tab to look 1, 3, 5 & 10 year returns of the funds for more insights.
Step 4: Filter the 5 year returns in descending mode by clicking on return under 5 year category and 10 year returns in descending mode by clicking on return under 10 year category, shortlist top 10 from each of these 2 categories. You will be left with less than 20 mutual funds (as there will be few overlaps) from the ocean of mutual funds.
Step 5: Now click on Risk Stats on sort the returns by Standard Deviation (lower is better), Sharpe Ratio (higher it is better), Alpha (higher is better) and make a note of these ratios for the funds you have shortlisted in the earlier step.
Step 6: Check the expense ratio of mutual funds under fees & details and make a note of them in a separate tab.
Step 7: This is where we will be making out our selection of mutual fund, sort out the results you have shortlisted by Standard Deviation, Sharpe Ratio, Alpha and finally by expense ratio and select the number of funds based on the decision you have taken earlier (can 1, 2 and never more than 3) and start investing.
I will post about the funds I have shortlisted but that is feed for another post and I will update this article once I have published it.
Between Us: Please let us know your views on this exercise of choosing the best mutual fund with conviction and in case if you are already a mutual fund investor please tell our readers about the process you have followed to select the mutual funds that you have invested till now.
Please share your feedback and additional inputs on this process so that we can fine tune the mutual fund selection methodology which would benefit each of us. Wouldn’t that be a win-win situation for all?