Consider these 4 factors before you zero-in on a Mutual Fund in 2021

By now, it’s clear that mutual funds are indeed ‘Sahi Hain’ for addressing different life goals. An asset class that has reached new heights in the last decade, the four-fold growth of the assets under management (AUM) of the mutual fund industry in the span of 10 years is a testament to its popularity and rising stature.

Having said that, given the sheer number of funds available, it often becomes a Herculean task to zero-in on the right fund.

You need to consider certain parameters before deciding to invest in your chosen fund, as a wrong investment can backfire and deprive you of leveraging the gains to the fullest from this asset class.

Financial Goals

Understand that every mutual fund under a particular category serves a specific purpose. Their objective is not the same. Before investing, it’s essential to have a holistic understanding of your financial goals and know what you want to achieve through your investment in a particular fund.

For example, for long-term goals such as children’s higher education, their marriage, or your retirement, it’s prudent to invest in an equity fund that has the potential to generate an inflation-indexed return in the long term.

On the other hand, if the objective is to build an emergency corpus or garner returns better than fixed deposits, liquid and debt funds should be on the radar. Marrying your goals with that of the fund helps you in making the right choice.

Being market-linked, returns from mutual funds are not fixed. However, the quantum of risk varies across funds. For instance, equity funds have a higher element of risk than debt funds.

Hence, it’s vital to have an accurate estimate of your risk appetite and see if it’s in tune with your chosen fund.

If the slightest of market movements make you jittery and give you sleepless nights, it’s advisable to stay away from an equity fund.

On the other hand, if you can stomach market volatility and have the patience to continue investments despite short-term market blips, then you can contemplate investing in a fund with a higher risk element and vice versa.

Do note that even debt funds are not completely risk-free, as highlighted in the recent turn of events that saw the winding up of six debt schemes by a prominent AMC. These funds carry credit, interest, and liquidity risks.

Often an overlooked aspect, investment horizon refers to the time you wish to remain invested to accumulate the corpus for a particular goal.

If you don’t need money on short notice and your goal is 10 to 15 years away, it’s advisable to go for an equity fund. Equities are less volatile in the long term and bring the power of compounding into play when you remain invested for the long haul.

However, if your goal is under 5 years, you can contemplate investing in hybrid funds that offer you the best of both worlds – equity and debt. For goals that are less than a year away, liquid and ultra-short duration funds should fit in the scheme of things.

The long-term performance of a fund, (8 to 10 years), gives you an idea of how well it has performed across market cycles vis-à-vis its benchmark index and peers.

If it has delivered high returns and the fund manager has been able to generate alpha, it’s vital to see how consistent it has been over the years.

For example, while analysing long-term fund performance, if you find that it has lagged behind in 8 out of 10 years and has delivered spectacular returns in the past 2 years, it’s better to take a step back and re-evaluate.

On the other hand, if a fund has consistently delivered decent returns in 6-7 years, it presents its case better for investment.

The success of your mutual fund depends largely on the selection of the right fund. Equally important is to stay patient and avoid knee-jerk reactions following short-term volatility.

The recent market rally has rewarded those who chose to swim against the tide when markets officially entered the bear phase in late March. Once you have zeroed in on the fund, remain committed to your investment to maximise your gains.

(Rahul Jain is Head Edelweiss Wealth Management)

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.