Mutual funds have become a popular investment option in recent years, attracting a growing number of investors through Systematic Investment Plans (SIPs). The Assets under Management of the Indian mutual fund industry has grown Significantly in the last few decades. This trend is likely to continue. There are two main ways to invest in mutual funds: directly or through a financial advisor. While using a financial advisor can be helpful, it also incurs additional costs.
This article empowers you to take control of your investments by guiding you through the process of analyzing a mutual fund yourself. Let’s see how you can analyze a mutual fund! To learn the basics about mutual funds and understand how to analyze mutual funds, read further.
Key Parameters for Analyzing a Mutual Fund
Here are 6 crucial factors to consider when evaluating whether a mutual fund aligns with your investment goals:
1. Expense Ratio
The expense ratio is a percentage of a mutual fund’s total assets charged annually to cover management fees and other operational costs. A lower expense ratio translates to higher returns for investors.
Mutual funds are typically offered in two plans: direct and regular. Direct plans eliminate broker commissions and other fees, resulting in a lower expense ratio compared to regular plans. Investors should compare expense ratios of different funds before investing, prioritizing those with lower fees. The difference in expense ratio might seem small, but it can significantly impact your returns over the long term. For example, consider two funds with a 10-year investment horizon. If one fund has an expense ratio of 1% and another has an expense ratio of 2%, a ₹1 lakh investment in the lower expense ratio fund could potentially yield thousands of rupees more in returns compared to the higher expense ratio fund.
2. Fund Performance vs. Benchmark Performance
A fund’s performance should always be compared to its benchmark index, which serves as a reference point. A strong performing fund will consistently outperform its benchmark.
For example, if a fund delivers a 20% return in a year while its benchmark generates 25%, the fund has underperformed. The excess returns a fund generates over its benchmark is known as alpha. Ideally, you should seek funds with a positive alpha, indicating consistent outperformance. When evaluating a fund’s performance, look beyond just the headline return. Analyze the fund’s performance across different market cycles (bull and bear markets) to gauge its consistency.
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3. Risk Level
Risk and return are intertwined in the world of mutual funds. Each scheme comes with a designated risk level (low, moderately low, moderate, moderately high, or high) to inform investors about the potential risks involved.
It’s crucial to choose a fund that aligns with your risk tolerance. Investors with a low-risk appetite should consider debt funds or hybrid funds that invest in a mix of stocks and bonds. Conversely, investors with a longer investment horizon and a higher tolerance for risk may consider equity funds that offer the potential for higher returns but also carry greater volatility.
4. Fund’s History
A fund’s long-term performance is a true indicator of its potential. Look for funds with consistent and stable returns over a period of 5-10 years. Ideally, the fund should have navigated at least one economic downturn, demonstrating its ability to deliver returns in both bull and bear markets.
For instance, a fund that delivered a high return in one year but has a history of inconsistent performance might not be a wise investment. Focus on funds with a track record of delivering steady returns over a longer timeframe. Analyzing a fund’s historical performance can also help you assess the fund manager’s investment style and philosophy.
5. Portfolio Turnover Ratio
The portfolio turnover ratio indicates how frequently a fund manager buys or sells securities within the fund. A high turnover ratio translates to more frequent buying and selling activity, which incurs higher transaction costs (brokerage fees, etc.) that ultimately reduce your net returns.
Consider both the expense ratio and portfolio turnover ratio to calculate the net return you can expect from a fund and compare it to other options. Generally, a lower portfolio turnover ratio is preferable, indicating a more patient and long-term investment approach by the fund manager.
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6. Fund Manager and Fund House
While the above factors are essential, consider these additional aspects as well:
- Fund Manager: Research the fund manager’s experience, track record with other schemes, and overall investment philosophy. This can give you confidence that your investment is in capable hands. Look for fund managers with a proven track record of success and a long tenure managing the fund.
- Fund House: Look into the reputation and history of the fund house managing the scheme. A well-established and reputable fund house with a strong track record of managing successful funds can provide peace of mind.
Beyond the Basics
While these six parameters provide a solid foundation for analyzing mutual funds, remember that investment decisions should be based on your individual circumstances. Consider your financial goals, risk tolerance, and investment time horizon. Don’t hesitate to conduct further research or consult with a financial advisor for personalized guidance
Disclaimer
This blog post is for informational purposes only and should not be considered financial advice. Investing involves inherent risks, and investors may lose some or all of their invested capital. Past performance is not necessarily indicative of future results. Do your own research and due diligence before making any investment decisions.
Please note: Finance Gurukul may have a business relationship with some of the financial products mentioned in this article.
