Wednesday, September 10, 2008

How to pick right Mutual Fund

There has been a lot of volatility in the stock markets. This year, there have been many sharp corrections and rallies in the stock markets. Currently, the Sensex is in the 14,000 levels which is over 30 per cent lesser than its peak in January this year. The net asset values (NAV) of equity mutual funds across the board have taken a beating this year - especially the mid-cap and small-cap focused mutual funds which have a higher co-relation with the market.

Investors who entered near the market's peak have lost a significant portion of their principal investments and others have seen a significant dip in their capital appreciation. Investors who invested in the wrong mutual funds are stuck with them.

In the current market conditions, many investors are pulling out investments in equity mutual funds and investing in debt funds and instruments - liquid funds, bank deposits etc. It makes sense for short-term investors as it is difficult to predict the market direction in the short term. Long-term investors should not park funds in debt instruments as the returns in debt-based instruments will be negative after factoring in inflation. Historically, equity-based investments provide positive returns over the long term. Long-term investors should look at investing in good equity funds systematically.

These days, systematic investment plans (SIPs) are being widely advocated by many investment advisors and positioned by mutual funds as an investment option to weather volatile markets. Although it does not guarantee positive returns, SIPs help in averaging the entry cost for investors, and hence reduces the chances of an investor being caught on the wrong foot. Often, investors find it difficult to pick the right category/scheme and end up making the wrong choice.

Here are some basic factors investors should analyse while investing in a mutual fund scheme:

Finance needs:
The first step is to estimate finance needs at different stages in life. This helps in understanding investment objectives.

Risk appetite:
The next step is to understand the risk appetite. It depends on many factors like source of earnings, number of dependents etc. Investors with a low risk appetite should go for blue chip funds or diversified equity funds, while investors with a high risk appetite can go for a mix of blue chip and mid-cap funds.

Timeframe:
Investors should invest in mutual funds with a long-term perspective. This way, your investment gets more time to grow, with the advantage of compounding. Time also creates a cushion to absorb risks, and hence reduces the risk of losses.

Track record:
Investors should look at the track record of mutual funds before taking investment decisions. For evaluation of a mutual fund's performance, investors should look at the fund's total returns - dividends, growth, tax savings etc). This information can be accessed from the mutual fund's periodic reports.

Mutual fund investors should avoid frequent switching from one fund to another. Switching from one fund to another involves transaction costs. Investors should have realistic expectations from investment instruments. Information available/quoted is past performance. Remember, the past performances of the instrument may not be repeatable.

Performance of mutual funds is highly dependent on the fund manager, fund house and their equity research teams. Investors should make a thorough analysis before taking investment decisions.

Courtesy: economictimes.indiatimes.com

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