Mutual funds are a great way to let your hard-earned money grow. There are many mutual fund schemes available in the market. To get the best out of your mutual fund investment, it is important to choose the right product. Each mutual fund scheme is designed to help investors achieve different financial goals. In this article, we discuss some important pointers that can help you choose the right mutual fund.
Consider Your Goals Before Investing
Your financial goals are an important factor while selecting a mutual fund. So as a first step, identify your financial goals. Your financial goals can be either short-term, medium term or long-term. For instance, if you want to build a fund for a home loan down payment or any other long-term financial goals, you can invest in equity mutual funds. For short-term financial goals, you can choose liquids funds or an ultra-short-term fund. For your medium-term goals such as an investment timeline of one to three years, you can pick up short-term debt funds after a thorough risk assessment. Therefore, consider your financial goals and timelines while selecting mutual funds. For different goals, you can diversify your portfolio by investing in more than one type of mutual fund across various underlying asset classes (like equity, debt, gold, etc.) and products within the same asset class. While selecting a mutual fund, also consider the time horizon. Horizon is the span for which you would like to remain invested in a mutual fund.
Assess Your Risk Tolerance
While selecting a mutual fund, ask yourself what is your risk tolerance. Identifying your risk tolerance will help you streamline your choices. Since there are different types of funds catering to different needs, they all involve low to higher risks. For example, liquid funds involve lower risk. Risk and returns are directly proportional to each other. So lower risk means lower returns and vice versa.
You can understand the selected mutual fund by assessing it based on its past performance. To make this process simpler for you, various rating agencies like CRISIL, ICRA, etc. come out with mutual fund ratings. You should always go for mutual funds with top ratings. However, besides the ratings, do check other important factors such as the fund house’s reputation, underlying assets, expense ratio, etc. Also, bear in mind that past performance is no guarantee to future returns.
The expense ratio is what a fund house charges its investors for various costs incurred for managing any mutual fund scheme. This is usually a percentage of the returns. So, while selecting a fund, it might be a better idea to go for a variant that charges a lower expense ratio so that you’re able to maximise investment benefits.
Investment returns should always be computed against its tax liability. The tax rate depends on the category of mutual fund and investment period. For instance, investment done for over a year in an equity mutual fund is considered long-term. Short-term capital gains (STCG) in equity mutual funds are taxed at a 15% rate. Long-term capital gains (LTCG) are exempted for an amount up to Rs. 1 lakh in a financial year and returns above Rs. 1 lakh is taxed at 10%. For debt funds, the tax rate for STCG is applied as per the applicable slab rate of the investor and LTCG is taxed at 20% rate along with indexation benefit.
The key to a successful mutual fund investment lies in optimal diversification and staggered investment so that the investment risk are effectively managed to generate desired returns. Do not invest only in a single asset class just because it is performing well. You should diversify your investment so that it can cater to your short-term to long-term financial goals.
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