Checklist for investing in mutual funds

Today, choice has become a tricky puzzle to solve. In your daily life, wherever you go either to a grocery store or a consumer durables shop, one obvious thing which you will find everywhere is surplus of choices which sometimes confuses your decision as to which product to buy and which to leave.

Similarly, when you think about investing in a mutual funds, you get wide array of schemes which may confuse you. How would you select an appropriate fund based on your goals and objectives? How does a common investor go about selecting the right mutual fund? This article attempts to solve this dilemma as far as mutual fund investments are concerned by introducing you to the "guide to selecting the correct fund based on your needs".

Following are some of the points which will help you to select an appropriate mutual fund:

Identifying investment goals and objectives

Before investing in any fund, an investor must first identify his or her goals for the money being invested. Are long-term capital gains desired or investment is done for a shorter period? Will the money be utilized for short term expenditures like a family vacation or to supplement a retirement that is decades away? It is very important that you always check whether the fund’s investment objective mentioned in the offer document is aligned with your investment objective or not.

Risk Tolerance

You must also consider the issue of risk tolerance. Are you able to afford and accept swings in portfolio value or are you more of a conservative investor? Identifying risk tolerance is as important as identifying a goal.

You can use the following steps to judge your risk appetite:

Step 1 - Know what you can afford to lose

Ask yourself what would happen if you lost some or all of the money you are putting into investments. This will depend on your circumstances and how much of your money you are investing.

Step 2 - Understand your personal risk attitude

Risk attitude is subjective and is likely to be influenced by current events or recent experiences. When stock markets are rising we tend to feel comfortable with market risk, when they are falling we do not. Most people are not comfortable with the idea of losing money.

You can keep risks in line with your risk appetite by spreading your money across a range of different investments.

As all of us know, markets will rise and fall, how much of a fall we are willing to accept is what we need to identify as investors. We also have to live with the knowledge that no asset class will forever move upward, similarly no asset class will be in a downward spiral all the time.

Select Funds with Low Expense Ratios

You should always choose a fund with a lower expense ratio. Expense ratio is the measure of what it costs to an investment company to operate a mutual fund. Remember, higher the expense ratio, a larger portion of your money is deducted as a fees by the AMCs, therefore this affects your returns as less of your money is invested in the market.

Select Funds with Low Portfolio Turnover

Portfolio Turnover Ratio (PTRs) is the measure of how frequently assets within a fund are bought and sold by the managers. Mutual Funds churn their portfolio to weed out bad stocks from their portfolio or exit from the fund, which has reached its target. PTR numerically measures the trading activity in a fund’s portfolio. It is the percentage of the portfolio that is bought and sold in exchange for other stocks. If the portfolio is churned many times during a year, the fund will incur higher transaction costs, which means a further impact on the amount you have invested in the fund.

Larger Portfolio Turnover Ratio will increase the expenses while churning. When the fund’s expenses increase, it, in turn, reduces the returns or yields of the fund. Therefore it is advisable that investors consider Portfolio Turnover Ratios before deciding to invest in a mutual fund.

Therefore, the next time you decide to park your hard earned money to invest in a mutual fund, the above points would act as your check list. Always remember, while mutual fund investing is not rocket science, these points can help you during your investment process. You are advised to take assistance of a financial advisor before investing.