How to select the right mutual fund?

We all know that mutual funds ‘sahi’ hai, but do you know which mutual fund is right for you? With thousands of mutual fund schemes available today, selecting the right fund can be a challenging task. If you are also facing this problem, here’s a basic ‘how-to-select-a-fund’ guide for you.

First of all, you should always remember that the right mutual fund is not the one that offers maximum returns, but the one that helps you meet your investment objectives. There’s no scientific formula to pick the best mutual fund. The best fund depends on the investment objective and therefore your best fund can be very different than the best friend’s best fund. Hence, you have to consider various factors in order to find out the right mutual fund for yourself.

These factors can be broadly classified into two broad approaches, i.e. Inside-out approach and Outside-in approach.

The Inside-out approach is about doing a self-analysis. This approach helps you recognise your investment objective, your investment horizon and your risk profile prior to making any investment decision. It’s important to understand yourself as an investor to know the kind of product that will work for you.    

Know your investment objective clearly. Some examples of investment objective that people have are generating wealth to buy a house, going for a world tour, saving for retirement and generating a steady flow of income; whatever may be your objective, knowing that is the first step. It’s important to know “why” you are embarking upon the journey or making the investment.

Next is deciding the investment horizon. Ask yourself ‘how far my goal is’ or ‘how much time do I need to reach this particular goal?’ Answer to these questions will understand how long you need to stay committed towards the goal.

As a final step, assess and know your risk profile. Assessing your risk profile helps you understand your risk tolerance level. Mutual Fund Investments are subject to market risk. If you are unaware of your risk appetite then you may end up investing into riskier schemes. It’s important to know your risk appetite to be able to select the right schemes – the ones that don’t expose you to risks greater than what you’re willing to take.

The inside out approach will help you identify the right mutual fund categories. For instance, if you are risk-averse and wish to invest for less than a year with earning better interest than savings deposit as your investment objective, then you may consider low duration, ultra short-term funds. However, if you wish to invest for more than five years and are willing to take higher risk with earning better interest than fixed deposit as your investment objective, then you can consider investing in equity/hybrid funds.

Now that you know which category is suitable as per your investment objective, you can zero in on the specific scheme/s within that category by following the Outside-In approach.

Start with listing down schemes on offer under your shortlisted category. Final step is to compare these schemes to identify the winner. Read our “How to compare Mutual Funds” article to understand how to compare different schemes and find the one that’s right for you.

Bottom line: The above mentioned guidelines can help you figure out the right mutual fund for you. Do proper homework before zeroing in on one scheme and make sure you have selected the most suitable mutual fund that will help you achieve your investment goals faster.