How do you Compare mutual Funds?
When an investor decides to invest in mutual fund, he gets lots of options in mutual funds. Mutual fund is broadly classified into 3 types: Equity, Debt, Hybrid. There are more than 2000 mutual fund schemes. Many options, many AMCs! Question is where to invest? How to compare mutual funds?
When we go out to buy a washing machine, we compare many models available in the market. But we decide as per our requirement, budget, performance and features of the machine. So, we do little bit research before buying a washing machine like taking all details of particular machine and comparing features and price of same with other models. We also ask friends for review or sometimes, we take reviews online.
Like that, when we want to compare mutual funds, we need to consider many factors, not only performance. See, you can’t only think about returns as mutual fund investment are subjected to market risk. It means, particular mutual fund which has shown good return will not necessarily show good return in long term. And mutual fund is a long-term investment. So, you really need to consider other factors too like where your money is going to be invested, annual fees charged by fund house, risk, etc
First step is to know your financial goals. Once you know your financial goals then you can know,
- how much return you are expecting?
- period
- your risk capacity.
Read also: A Beginners Guide to Systematic Investment Plan
But, all the funds in particular category look similar. Then, how to select one from those options available? To compare mutual funds, we will consider following factors.
- Benchmark
- Investment Horizon
- Risk
- Expense Ratio
- Sector Allocation
Benchmark
As per SEBI’s guidelines, each mutual fund has to declare benchmark. Benchmark is an index against which a mutual fund’s performance is measured. Benchmark is used to understand the performance of particular mutual fund. If the mutual fund performs better than benchmark index then mutual fund is said to have outperformed the index. Ideally, a Mutual Fund’s target should be to match its benchmark return.
Investment Horizon
Investment horizon means how much time you are going to stay invested in mutual fund. Its very important factor as different types of funds have different time horizon. Like, if you are planning to make long term investment then equity mutual fund is a good option. Equity mutual fund perform better if you keep investment for long time. But if you want short term investment then liquid funds is a good option.
When you are comparing mutual fund return then investment horizon should be considered like if you are comparing two equity mutual funds then return of last 5 years to 10 years should be considered. But, if you are comparing liquid funds then return of last 1 year should be considered.
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Risk
Mutual fund investment is not risk free. There is a risk involved. It is said that higher the risk, higher the return. But it doesn’t happen always. You need to consider better measure for comparison when you are comparing mutual funds on the basis of risk. Alpha and Beta are used to evaluate performance of mutual fund. Alpha is calculated depending on the extra return created by an investment after it fulfils its risk criteria.
Beta determines the risk associated with a particular fund depending on its benchmarking index. Fund which has a Beta ratio of more than one is usually considered volatile. Beta ratio of less than one is considered less risky in comparison with its benchmarking index.
Expense Ratio
Investment in mutual fund costs customers annual fees. This annual fee is charged by fund house to manage customer’s portfolio. Expense ratios means how much the mutual fund charges in terms of percentage annually to manage your investment portfolio. So, expense ratio is also an important factor as it impacts the return on investment.
If you invest Rs.2,00,000 and expense ratio is 2% then you need to pay Rs. 4000 to fund house to manage your money.
Every fund had different expense ratio as every fund has different management fee. Compare same type of mutual funds.
Sector Allocation
Mutual fund invests capital in different sector according to investment objective. For example, as per the guidelines of Securities and Exchange Board of India(SEBI), a multi-cap fund should have a mandatory asset allocation of 25% in each of large-cap, mid-cap and small-cap stocks. Such an allocation affects the risk related to mutual fund.
Takeaway:
We read how to compare mutual funds, what factors to be considered in comparing mutual funds. Compare 5 years return of one fund with 5 years of another fund. Don’t compare 3 years return of one fund with 5 years return of another fund. Compare same type of fund like growth plan of one fund with growth plan of another, not dividend plan.
