Thinking of investing in mutual funds? Here’s how to pick the right fund

Summary

  • An SIP is an investment technique wherein an investor does not try to time the market by waiting for a dip to buy.
  • An index-based mutual fund basically tries to replicate the performance of its underlying index such as the ASX 200 in Australia.
  • A balanced mutual fund consists of both the equity and debt component.

Mutual fund is an investment fund, in which many retail investors pool their money with an expectation to earn a return on their capital.  This pooled investment is channelised towards different asset classes such as bonds, equities, etc. A dedicated fund manager, who is assigned to every mutual fund, makes all the key decisions such as which company to invest in, size of the investment, when to exit a position, etc.

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One of the major benefits of a mutual fund investment is that it provides a readymade portfolio of securities to investors, making their investment journey an easy one. The most famous strategy of investing in a mutual fund is the Systematic Investment Plan (SIP).

An SIP is an investment technique wherein an investor does not try to time the market by waiting for a dip to buy. He/she regularly invests in the mutual fund at a fixed time interval, say monthly, irrespective of the Net Asset Value (NAV)of the fund at the time of investment. This regular investment helps investors average their cost in the long run, eliminating the need to be super accurate on timing their entry.

How to select the fund which is right for you?

Although mutual funds could be the right investment for you, but there are quite a few types of funds, all catering to different risk and reward profiles. Selecting the best fund for yourself depends on your financial goals, risk profile, timeframe, etc.

To make the job easy for you, let’s have a brief look at a few types of mutual funds and the type of investors for which they are ideally suited.

Read More: What is a Hedge fund and how is it different from a mutual fund?

  1. Mutual funds based on market capitalisation

The is the most common kind of classification for mutual funds. All listed companies in the stock markets are not of the same size and vary considerably in their scale of operations. For example, a company could be quite small and serving its domestic country only. On the other hand, there are some mammoth businesses such as Google, Microsoft, Apple, etc which almost serve the whole world.

Small companies, also known as small-caps, are the riskiest companies to invest in. As they are quite small, their future outlook is relatively difficult to gauge. Investors, with higher risk appetite generally prefer small-cap mutual funds, as they also deliver potentially higher returns, to compensate for the high risk.

Similarly, a mid-cap fund offers a lower return and incorporates a lower risk as well. However, a large-cap fund, which includes the most robust and well-established businesses, offer the safest returns of all three categories. Thus, investors can choose the suitable fund based on their risk appetite.

  1. Index-based mutual fund

An index-based mutual fund basically tries to replicate the performance of its underlying index such as the ASX 200 in Australia or the Dow Jones Industrial Average in the US. They do not try to offer outperforming returns as their aim is to deliver a return at par with what their benchmark is delivering.

This fund is for conservative investors who do not wish to take higher risk and are satisfied, sticking to the index constituents. As these are passively managed mutual funds, the management fee is quite low.

  1. Sector specific fund

Sometimes an investor has high confidence in a specific sector and believes that sector to outperform the broader market in the future. He can choose these sector-specific mutual funds, which invest in companies from a single sector.

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For example, there are mutual funds based on the financial sector, which only invest in the companies that operate in this space such as a bank or a lending company. This is a high-risk strategy because all the funds are invested into a specific sector, so in case the sector takes a back seat, heavy losses could be incurred.

  1. Balanced fund

Most of the times a mutual fund is 100% invested in equities, giving it a higher volatility, higher risk and higher return profile. However, if you need a relatively stable fund, with more protection to the downside, a balanced fund could be an ideal choice for you.

A balanced mutual fund consists of both the equity and debt components. Bonds which are relatively safe and less volatile asset class help in adding some stability to the fund and protect it from the volatility of equity markets. On the other hand, the equity component continues to generate higher return with higher risk.

The combination of both parts helps the mutual fund to deliver a return higher than what ideally a debt fund alone would generate; at the same time, it also results in more stability than a 100% equity portfolio. 

Read More: Curious about Mutual funds? Here's why one should invest in them

 

     

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