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5 Things to Remember before Investing In A Mutual Fund

In this article, we will talk about the 5 most important things you should keep in mind before investing in mutual funds.

Updated:February 13, 2019, 5:00 PM IST
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5 Things to Remember before Investing In A Mutual Fund
In this article, we will talk about the 5 most important things you should keep in mind before investing in mutual funds.
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Mutual funds today rank among the most popular instruments of the investment world. In recent times, this investment instrument has attracted investors' interest by providing them with high returns in both short and long term periods. In this article, we will talk about the 5 most important things you should keep in mind before investing in this great investment instrument. Let’s begin with first understanding what is a mutual fund?

A mutual fund is a professionally managed investment instrument wherein a large number of people invest their money in equities, bonds, money market instruments and/or in other securities. By investing in a mutual fund, you get a share of the fund’s gains, losses, income and expenses proportional to the amount of your investment. Mutual funds can be broadly categorised into three categories - Equity Funds, Debt Funds and Hybrid Funds.

How to Know Which Mutual Fund is the Best for You?

There are a number of mutual fund schemes available in each category. And sometimes it gets difficult to know which one best suits your financial goals. However, this decision can become easy if you keep the below discussed 5 things you into consideration while choosing a mutual fund. It is important to note before understanding how to select a mutual fund, it is important to note that the best mutual fund scheme is not the one which gives you the highest returns, it is rather the one which best suits your financial goals and risk appetite along with giving good returns.

1) Investment Objective and Risk Tolerance

On your way to selecting the best mutual fund, begin by assessing your investment objective and risk tolerance. If you aim to earn capital gains for more than a year, choose a long-term mutual fund scheme wherein your money gets pooled in for a period of at least 12 months in case of equity or a balanced mutual fund and for at least 36 months in case of a debt mutual fund. However, if your investment objective is to earn current income, you should go for short-term schemes.

Similarly, if your risk tolerance is high, go for equity mutual funds, otherwise, choose
a debt or a balanced mutual fund scheme which tries to offset the involved risk by investing in both equity and debt instruments.

2) Mutual Fund’s Performance Consistency

Another important thing to check before investing in mutual funds is the scheme’s performance over the long term. Instead of checking how much returns the scheme has generated in recent times, base your investment decision considering how it has performed over the past 1, 3 or 5 years. It tells you if it is capable of giving you
consistent or just whirlwind returns. You can get the data around it online from the factsheets of various asset management companies or mutual funds research websites.

3) Compare the Mutual Fund With Its Peers

Just knowing a mutual fund scheme's own performance is not enough. For a holistic understanding, it is also important to check how it has performed among its peers. Remember this comparison should only be among the same type of mutual fund schemes. For instance, a large-cap mutual fund scheme should not be compared against a multi-cap mutual fund scheme. For this, you can check a scheme’s quartile ranking which shows how it has performed on a quarter-on-quarter basis among its peer group. This data is also easily available online.

4) Mutual Fund’s Expenses

All the expenses incurred in managing a mutual fund scheme is borne by the scheme. Thus, it becomes necessary to check what proportion of the returns earned by the scheme is swayed away by its expenses. For this, check the scheme's Expense Ratio- lower the ratio, better is the scheme. According to industry standards, an expense ratio of 1.5% is considered a viable deal. The expense ratio of the direct variant of a scheme will always be lower than its regular variant due to the absence of commission which one pays while investing in a regular mutual fund scheme.

5) Fund Manager’s Experience

Another important factor to consider before investing in a mutual fund scheme is its fund manager’s experience. It is important to check for how long the fund manager has been at the helm. It is equally important to check whether he/she has managed the fund during the fund’s best and worst periods or not. For a new fund manager, you can check his/her previous record with other funds of the same fund house or a different one.

Taxation of Mutual Funds

An investor receives two types of incomes from a mutual fund investment namely dividend and capital appreciation. While the tax on dividend known as Dividend Distribution Tax (DDT) is deductible at the rate of 10% at the hands of the fund house, the tax on capital appreciation known as Capital Gains Tax is paid by the investor.

The capital gains tax treatment of different mutual funds schemes is as below:

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