“All that glitter is not gold” – It’s an old saying which still holds true in today’s world. We often fall for products which are well advertised or promoted by the manufacturer but rarely consider whether the product is suited to us. We then decide to buy it simply because everyone we know has bought one.
This decision becomes critical when it comes to financial products and services as they fund your future needs and involves hard earned savings. It is therefore important to choose an avenue which suits you well. Choosing the right mutual fund becomes a crucial decision and there are numerous criteria to consider while choosing the mutual fund suited for you.
The Mutual funds universe consists of more than 12,000 schemes for investment and to select a handful of them is not an easy task. With the availability of so many schemes, a portfolio can be diversified and customized to an individual’s suitability. But more often than not we follow clichéd methods and beliefs and end up buying a fund which seemingly looks attractive. The following are some of the ways by which we end up buying an unsuitable mutual fund.
1) Stay away from your so called “Financial Advisor”/ Broker
Just like insurance in the past we end up trusting the agents or so called financial advisors for mutual fund advice. In some cases they said advisor would be advising you on mutual funds as well as insurance products, both of which are non productive. Mutual fund houses have attractive incentives for the advisors, hence there is every chance that the fund advised to you has more benefit for the advisor than you. These advisors may not have done even the most basic research while recommending the fund. Moreover, the advisor himself may not be well equipped with the required knowledge about Best Mutual Funds.
2) Big brand does not mean good fund
Suppose you want to buy a large cap fund for which you would have at least 150 options amongst 30-40 fund houses. Which fund will you choose? In general, we tend to move towards the fund from a bigger fund house and avoid any smaller brands. Investing in mutual fund should not be associated with “Brand”. The reason being a large cap fund consist of stocks from the Top 100 companies in India only and all Fund Houses has access to each of these stocks. Hence a large cap fund should be selected irrespective of the fund house it belongs to. Yes there may be a difference in servicing, website and operations, but from the fund standpoint these factors have little impact on its performance.
3) Big guy, safe guy ! Not applicable always
There are other measures some investors use to choose their fund-namely the fund size and the fund age.
A bigger fund size would indicate the fund has attracted a lot of prior investors, which in turn would mean there is a certain reliability in the fund. The counter argument for this would be that having such a big AUM (asset under management) makes the fund manager less flexible as in order to make minor changes in the fund holding
- He has to make big amount of sell offs in the fund and hence the flexibility of the manager is very low.
- Any shift in the fund holding may end up selling huge amount of stocks at a lower price and buying huge amount at a higher price.
Imagine a fund having 10,000 crores of AUM and we to add a new stock by replacing an older one. Suppose the share of the old stock is least 3% in total fund holding, then he has to sell stocks worth 300 crores and again buy new stocks worth 300 crores. Now selling 300 Crores of shares can only be done at a slightly lesser price per stock while buying stocks worth 300 Crores attract a slight premium for such a large amount of investments.
That is why a larger AUM affects the NAV of the fund. On the other hand, a fund of a smaller asset size allows the fund manager more flexibility in making such changes and keeping the fund up to date.
Similarly older the fund would indicate that the fund has performed well since its inception. However, the historical data of the fund must be studied before taking a decision. The older the fund, the more historical data available thus more information about the fund’s performance in the past can be known.
4) Star rating/ranking are not an Advice
A lot of research website use some techniques to rank or rate a fund to ease the fund selection process. These ratings can be misleading to an investor especially if they consider the ratings as an authentic advice instead of just a suggestion. Most of the funds are ranked based on their past returns and the comparison with the respective benchmark. And the numbers are not incorrect, there are funds which have consistently beaten the benchmark in terms of returns.
But on other hand, one has to understand the reason why the fund is beating the benchmark consistently. One of the reason could be an excellent fund holding pattern i.e. choosing the best amongst the benchmark and beating the index. Another reason could be that the fund could be holding some stocks from another fund class and these stocks boost the returns making the fund superior to other funds. For Example, a Large Cap fund having some small cap equity holdings consistently yielding higher returns against its benchmark. This holding increases the risk which the fund carries in general is higher than the benchmark. This can cause trouble where the markets are falling and you experience the funds falling faster the benchmark itself.
Imagine buying a car based on your needs. Decision on a car depends on the budget, preference of either fuel saving or performance, purpose of the car and engine capacity. If you do not know how to choose, you ask some experts who know a lot about cars instead of just falling for an attractive hoarding besides the flyover. Same logic applies to mutual fund selection. You need a professional who is well equipped and has good experience in the finance markets to help you analyze the Right Mutual Funds for you based on risk appetite, future goals etc.