Investing in mutual funds? Five things new investors should keep in mind

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Mutual funds have gained growing acceptance among retail investors over the past decade for achieving their financial goals and parking short term surpluses. However, lack of fundamental understanding about mutual funds and capital markets may lead new investors towards wrong investment decisions.

Here are five MF investment tips for new investors:

Align investments with your financial goals

Aligning investments with financial goals can help determine your monthly investment and investment horizon. Having a predetermined investment horizon for achieving your financial goals helps estimate whether you should invest in equity or debt oriented funds.

For instance, while equities are volatile in the short run, they can beat fixed income instruments and inflation over the long run by a wide margin. Thus, investing equity mutual funds will create bigger corpuses for your long term financial goals. Likewise, as fixed income investments come with higher income certainty as compared to equities, debt mutual funds would suit financial goals maturing in the short term.

Review investment strategies and objectives of funds

All mutual fund schemes have to clearly mention their investment strategies, asset allocation strategies and broader fund management styles. Reviewing the investment strategy and objective of mutual funds before investing will help understand whether that fund is a correct match for your financial goals and risk appetite.

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Retail investors can get the fund’s investment strategy and objective in KIM (Key Investment Memorandum), SID (Scheme Information Document), product presentation, product leaflets and various other product literature.

Check past performance of the fund

Investors should make sure to compare the past performance of the funds with the performance of its benchmark indices and peer funds over a 1, 2, 3, 5, 7 and 10 years’ time frame. While past performance of a fund does not guarantee the same performance in the future, comparing its previous track record would help understand how a mutual fund performed under various economic and market conditions in the past compared to its peer funds and benchmark index.

Factor in fund’s expense ratio

Expense ratio of a mutual fund refers to the proportion of its average daily net assets used for meeting its annual operating expenses. These operating expenses include advisory and management fees, commissions paid to the distributors, audit and legal fees, registrar and transfer agent fees, marketing and selling expenses and fund administration expenses.

Lower expense ratio means a higher amount of funds would remain invested in a mutual fund for future growth and compounding. Expense ratio would especially play a crucial role during the selection of short term debt funds as they have limited upside potential.

As the direct plan of any mutual fund scheme has lower expense ratio than regular plan of the same scheme, investors should opt for direct plans to generate higher returns. While the outperformance of returns may appear to be marginal in the initial stage, the difference in their corpus generated can become sizeable over the long term due to the power of compounding.

Check the experience and reputation of fund house

While many investors give higher importance to fund managers while evaluating the fund’s potential, the fund house and its investment philosophy also plays a vital role in the future performance of any fund. A good fund house would always give more importance to creating strong organizational procedures and quality fund management teams instead of solely relying on fund managers. Even if a performing fund manager leaves a good fund house for better opportunities, the strong organizational process of that fund house can ensure continued out-performance of funds in the future.

Similarly, a fund house with rich experience over all kinds of market cycles would be better armed to face economic uncertainties and market volatility. Proper knowledge of the experience and reputation of fund houses would also assist you in assessing their NFOs or New Fund Offers, which come with zero historical data for benchmark indices and peer comparisons.

(The writer is Director, Paisabazaar.com. Views expressed are personal)