The most common question that I get asked in every investor education session that I speak in is, How do we choose the funds? I know it can be very confusing for a layperson to choose the appropriate fund(s). And the dilemma worsens when one has to choose from close to 45 mutual fund companies with more 1000 schemes.
So before you decide to start investing, do a bit of homework, read about the fund(s), even if you have an advisor who makes your financial plan.
There are 3 simple aspects to consider while choosing a fund
- Time required to achieve these goals (Break it up as Short – less than 2 years, Medium – 2-5 years and Long – More than 5 years)
- Risk that you are willing to take.
As they say, always start with Why. Begin the investing process with the destination or goal for which you are investing. Once you know the destination, deciding the route becomes simpler. The route is decided based on the time required for achieving the goal. Now you may not need all your goals to be accomplished at the same time. Some will be long term and some could be short- or medium-term goal. So put down the time lines for each goal that you wish to achieve.
Once you have decided on the destination and timelines, then of course comes the risk you are willing to take, low, medium or high. Each one of you has a different risk-taking capacity, based on your age, life experiences, number of dependants, whether you are single- or double-income family, etc. So don’t go by what others are doing, choose your own path.
Coming to the investment objective, in the short term it should be capital protection and that can be provided by Debt funds (Please note Mutual Funds do not guarantee that). So for all your goals that are short and Medium term, you can choose Debt Funds. These funds offer you products that have timelines ranging from overnight to 2-3 years.
The investment objective in the long term should be capital growth or capital appreciation and that can be provided by Equity funds. Needless to say, the growth or appreciation comes with some amount of risk. Again, Equity Funds offer a range of products that go from low risk to very high risk.
So reading 3 basic things about the fund is very important before deciding on investing in it. Investment objective, Product suitability and the Riskometer. It is clearly mentioned in the Scheme Information Document(SID). The SID also displays the Riskometer that shows the risk involved in investing in that particular fund.
There may be around 350 Debt Funds and Equity Funds schemes each, So past performance may be a good indicator to shortlist it further. Consider past returns of atleast 3-5 years for the equity funds.
Spending some time reading about the funds will not only help you in taking informed decisions but also in asking the right questions to the advisor.