Mutual funds: Choosing the best option

* What is it that I am trying to achieve from my investment? – Am I looking at generating X amount of returns or do I want a steady appreciation on the capital invested or is it my objective to generate some wealth from the investment which will help me achieve a particular financial goal.

* For how long do I want to stay invested – is my investment for a short period or am I willing to stay invested for long,say 10 years?

* How much risk am I willing to take on the investment – Will I be able to cope up with momentary loss or would I prefer selling off the investment instead of taking any loss

* Am I in a position to invest one time or will I be more comfortable investing in bits over a period of time

If you diligently answer the above questions,the long list of available options would automatically get curtailed to a far more manageable number. Answering the above questions would also allow you to pursue those schemes which are more relevant instead of trying your luck purely on the basis of past performance or other ad hoc factors. As Ralph Seger,an Investment Guru once said

“An investor without investment objectives is like a traveller without a destination.”

Having zeroed down on your investment goals and preferences,you need to dovetail these with the investment objective of the scheme. Every mutual fund scheme has a clearly defined area of investment which it focuses on. You need to make sure that your investment goals are in line with the investment objective of the scheme.

Another important aspect that you need to consider is the risk profile of the scheme. There could be a situation wherein the scheme’s investment mandate matches your requirements however its risk profile may not be in line with yours. For example,you may be someone who avoids highly risky situations but the scheme which you have chosen may be investing in say small and mid-sized companies which are relatively more risky. In this case,you would be better off staying away from it as you may not be able to cope up with its volatile performance. To quote Warren Buffet,“The most important quality for an investor is temperament,not intellect.”

The third factor that you need to consider is the investment horizon. While most equity mutual fund schemes are open ended i.e. without a specific investment time frame,debt schemes generally have a specific investment horizon which is reflected in the instruments that they invest in. Even in case of equity,you need to be clear that you are willing to wait for a reasonable period of time,say 3 — 5 years to allow your investment to fructify and generate returns instead of bothering about the day to day variations in terms of its performance.

While these are some factors that you should consider,there are some pitfalls to avoid while arriving at your investment decision.

The most common measure that investors tend to rely on is the past performance of a scheme. While it does give one an indication of how the scheme has fared,it does not mean that it deliver similar returns in the future. As Warren Buffet once quoted: “If past history was all there was to the game,the richest people would be librarians”.

Size of the fund is another factor that attracts investor attention since the larger the fund size,the more the comfort factor that several investors have bestowed their trust in the scheme. While this is true to an extent,very large sized funds face the issue of liquidity especially if they focus on small/ mid-cap stocks since such funds may not be able to sell or buy into a preferred stock due to lack of liquidity available in the market.

Last,it is best to avoid new funds which promote exotic mandates since most of the time these tend to be fads with limited capability to ensure long term sustenance.

To conclude,investing like any other activity needs to follow the ingenious learning of life — stick to the basics,be clear about your goals and your preferences and the rest will fall in place.

—The author is Head,Marketing and Corporate Communication,Mirae Asset Global Investments