“Mutual Funds are subject to market risks.”
We all have heard this piece of cautionary advisory after every mutual fund(MF) ad. Even though it is true, a number of rookie investors still believe that the success of a mutual fund investment is solely dependent on fund managers and, of course, luck.
Hate to burst the bubble but this isn’t true. Contrary to the popular belief, fund managers did not pop up from a secret tree of financial ken; they were trained to master their trade. So, assessing and evaluating a mutual fund is NOT an alien technology.
Bottom line: Everyone can make smart investment decisions with the proper know-how.
Before investing in MFs, you must check the returns and risks associated with the said fund. A mutual fund calculator is a tool that can help you dojust that. In order to maintain a robust investment portfolio, balancing the returns and risks is imperative.
While Mutual funds do come with some key benefits like liquidity, diversification, professional management etc., choosing the right fund, among the hundreds out there can be quite tricky. The following is a handy list of 6 key criteria that can help you choose a suitable mutual fund online.
Maturity profile and average maturity criteria relates specifically to debt schemes. Maturity of a bond refers to a predetermined period after which it will either have to be renewed or bought back by the issuer. In case the bond is bought back, theprincipal along with any interest is repaid to the investor or depositor.
Typically debt funds invest in multiple bonds of various maturities and the average maturity is calculated based on the amount invested in specific bonds and their individual maturity using the weighted average formula. The average maturity data is disclosed and updated by the fund house in case of every debt fund. From an investor’s view point, lower average maturity translates into lower interest rate sensitivity and higher average maturity translates to greater interest rate sensitivity. Lower interest rate sensitivity equals lower risk for the investor and vice versa.
This criterion too relates to debt schemes. Credit rating provided by specialized credit rating agencies represents the potential risk of a specific bond that the debt fund is invested in. So obviously bonds that are rated higher are potentially low risk with government securities or G-Secs being considered risk free investments. There is of course a trade-off as lower risk equals potentially lower returns and that’s why G-Secs feature some of the lowest ROI on investments. So logically, lower rated bonds offer highest returns through higher coupon rates to offset the inherent risk of the investment. In case you are seeking an aggressive debt scheme with potentially high returns, do opt for a scheme that invests in a mix of low, mid and highly rated debt instruments. Otherwise lower your overall risk by opting for a debt fund that invests mainly in highly rated securities.
Portfolio Diversification Levels
The recent SEBI directive with respect to standardization and rationalization of schemes has thrown new light on how equity mutual fund schemes diversify their portfolio. The two key types of diversification prevalent today are market cap based and sector based diversification. Rule of thumb – sectoral/thematic funds that have minimum sector diversification feature potentially the highest levels of risk and returns. On the other hand, diversified schemes that feature sector and market cap agnostic investments are considered to provide an optimal balance between risk and returns in the long term.
P/E Ratio of Equity Schemes
A typical equity scheme feature, the P/E or price to earnings ratio can also guide an investor to a suitable scheme. In case of mutual funds, the P/E is calculated based on the weighted average of individual P/E values of each individual equity investment of the fund. The P/E data too is freely available from the fund house however interpreting it is a different story. Typically a lower P/E ratio indicates a potential value investment i.e. a future outperformed, whereas a higher P/E ratio usually indicates an inflated valuation with potentially lower future growth potential. However, one should be careful to choose an appropriate baseline level as baseline P/E ratios tend to vary from one industry to another. For example a P/E ratio of 16 might indicate potential value for the banking sector, but this same value might indicate overvaluation for the paints sector.
In order to determine the volatility in returns and get a clearer picture of the overall portfolio risk, standard deviation is used. It helps in calculating the variability of the returns of an investment portfolio. The lower the standard deviation, the better it is for investors. For liquid schemes, it can be as low as 1 percentor less while for equity mutual funds, the standard deviation can be anywhere from 20 to 40 percent.
If you want an early exit from your mutual fund investment, you may have to pay a penalty called the Exit Load. It is charged as per the load structure during fund redemption and typically ranges from 0 to 1 percent of the total redemption value of scheme units. A low exit load is better, as it means more returns in your hands.
Making smart investment decisions isn’t something only pro-investors can do. It is the matter of having sufficient knowledge, keeping an eye on the market trends and predicting the implications of the said trends that draw a line between a rookie and a pro.
At the end of the day, a fund manager manages what you choose; hence, your returns depend upon your decisions more than anyone else’s.