In my previous blog, I highlighted an autonomous system for regular saving habit, which lead to SIP in mutual fund. In the same blog I also highlighted benefits of investing via SIP and how you can create wealth from the same. This time I am continuing with the same theme which would enable us to select a mutual fund for SIP or Lump sum investment.
When I meet interested mutual fund investors, I encounter same question every time. They ask “How do we select a mutual fund?’ This question amuses me. So like all other self – respecting financial advisor, I start with the – “Well, it depends……’
Then I ask them “What are your investment goals, if any ?” Now if you have long term goals, does the choice of a mutual fund really matter? If you want to invest for short term i.e 1-6 month, you are going to invest in liquid fund. It hardly matter in which liquid fund you invest. The performance difference between two liquid funds is not so high. Basic criteria to choose a liquid fund is high AUM (Asset Under Management) along with good services in terms of purchase-redemption via phone or net.
However, if you are looking for a long term investment- which means you are looking to be invested for atleast 7-8 years, then you should invest in equity mutual fund. So let’s have a look at what you should consider while selecting a good equity mutual fund for long term.
The first and most important step is to have an investment goal or an objective. A fund selection done without having any investment objective is completely useless. Investors should know the reason for their investment i.e. how long you can stay invested and at what stage you will re-allocate your investment.
This will lead to a correct asset allocation. This factor is very important as it will decide how much money you will put into the equity mutual fund.
If you want to invest in equity mutual fund as first time investors go for large cap equity diversified fund. Do not buy any thematic, contra- opportunistic or international fund. In India, all funds are entry load free fund, so there is no hidden sales cost. This seems to be good means through which all your money gets invested without any charges.
Look at Asset Management Charges: As an when funds deliver good return it attracts lots of investors. Resulting into increasing fund size over a period that ultimately leads to lower asset management charges. So look at well managed fund with huge AUM and expense ratio below 2.3% P.A.
Look at Portfolio Turnover Ratio: The greater the fund’s turnover ratio, it is more likely the total cost will increase. One cost which is not visible to us is fund’s brokerage. With lower turnover ratio will typically incur lower cost. So look at fund having lower expense ratio.
The fund house and the team managing it is also important. Look at the experience of the fund manager and his team and evaluate if they have gone through few market cycles. At least a fund manager should have a proven track record of facing bear and bull cycle of the market.
True to label: When you buy a large cap fund, you are buying large cap fund. It is as simple as that. If fund house is saying it is a large cap fund it should mean that they are not buying mid cap and small cap even though large cap goes out of flavor for some time. They stick to their label and philosophy and you should respect that.
Philosophy Matching: Some fund houses are cool and calmer than others. In that case you need to find out which philosophy matches with yours. For Example, Templeton says Franklin India Bluechip is “growth’ oriented large cap fund. Whereas Templeton India Growth fund (Rename to Templeton India Value Fund) is a ‘value’ oriented fund. In that case see which philosophy matches yours. HDFC Mutual Fund, on other hand does not classify itself as either ‘growth’ or ‘value’. The investment philosophy is rooted in a set of well established but flexible principles that relies extensively on fundamental research.
Fund management by a team or star fund manager: A good manager is like a stamp and is able to deliver good return while staying with his conviction whereas some fund houses have been able to create teams and systems to handle the departure of fund manager. If a star manager leaves fund house, sometimes we keep wondering now what? This is the main reason that some fund houses believe in a system based approach, so that the performance is not compromised if a fund manager has to leave the fund house.
Do not chase performance: The fund which performed good in one quarter, it is possible it may not perform in next quarter. In a longer period, funds return should be more than its benchmark return and it should consistently deliver good return. This indicate consistency of the fund.Considering the performance of the funds , consistent funds are more preferable to those funds which either top of the list or at bottom of the list. Remember, long term investing is like running a marathon – stamina is more important than the speed.
All distributors and investors usually have their list of fund houses and schemes. Schemes on this list tend to pass all the above parameter- good long term performance, consistent good return, fund manager and the team having experience through bull and bear phases and the fund should be true to its label. More importantly with increase in fund sizes, the fund schemes have to reduce their charges thus increasing the total return an investor gets in his hand. .
If you are investing in equity for a period of say 5-6 years, invest by any of the mode, SIP mode or lump sum, one should keep in mind that portfolio goes through ups and downs and that could hurt an investor psychologically rather than financially. But at the end patience is a virtue that keeps you afloat.
“Equity is not to get rich fast. It is just that equity compound wealth at a higher than other assets. Be ready to get rich slowly.” – D. Muthukrishna