If you have made up your mind about deciding to invest in mutual funds and are unsure about how you should go about it, there’s no reason to fret. While it may appear to be a complex entity, it is quite easy—if you’ve got your basic thought process right. Having said that, it might be worth noting that there is no sure shot formula that can rain you a handsome profit.
The ideal strategy is simple—you want to invest in a mutual fund that provides you with high returns at a low cost. However, choosing the right type of mutual funds can be tricky since you would need to factor into consideration a couple of things. Here are 5 ways you can choose the right type of mutual funds for your portfolio:
I. Identify your Goals and Risk Tolerance
Investing in mutual funds can be difficult with the ocean of options available in the market. The natural course of action in this situation would be to figure out what your goal is for this investment.
Try and identify the time horizon that you’re aiming at—if you need a current income or for the long-term. For example, you might want to make money for college education or for a peaceful retirement. Since this is an investment, you will also have to keep your risk tolerance in check. For example, either you can tolerate a portfolio that can give you returns that are on two ends of the spectrum or you prefer a conservative approach to give you modest returns.
Once you have decided what your goals and risk tolerance are, you’ve essentially narrowed down to a sample set that is going to be much smaller than with what you initially started out.
II. Calculate Your Expense Ratio
An expense ratio is essentially the amount of money it takes to run a mutual fund. Generally, funds have an expense ratio of around 1%. When you say that fund has an expense ratio of 1% per annum, it means that 1% of the fund’s total assets are used for the company’s operating expenses such as analyst salaries, office rent, electricity, etc. So, the mutual fund will have to earn at least the expense ratio, to earn a profit.
It’s simple—choose a fund that has the lowest expense ratio. If you’re stuck between two funds that has 0.25% and 1.25%, respectively, choosing the one with the higher expense ratio would not be the best option because it would be more difficult for that fund to pump money. While it does not seem like a huge difference, it can really turn out to be a make or break situation, in the long run.
III. Choose the Right Portfolio Manager
Money in the wrong hands can be detrimental. Doing a background check on portfolio managers should not be difficult at present. Blacklist any manager that has is not active or has any history of losses during a bull market.
Associate yourself with a well-established firm that has a strong team of analysts and managers. You can check if these managers are investing any portion of their wealth with other fund holders. This helps you understand if they are genuine about their suggestions since they are putting their own money on the line.
IV. Don’t Buy Mutual Funds with a Sales Load
It is important to keep your eye out for something known as a sales load. This is basically the cut given to the person who sells you the fund. Think of it as brokerage fee that you sometimes pay to a broker to rent a flat. This fee should be avoided at all costs. You should aim to buy only no-load mutual funds.
While you might be swayed by a strong sales pitch, there is no reason why you should think that you can’t get this free-of-cost.
Also Read: An answer every investor must know
Diversify your Assets Well
If you simply own three different mutual funds in one sector, then that does not qualify as diversification. You will find yourself in a pickle if something were to happen to that sector on a large scale.
So how do you diversify?
- Branch them out – You have probably heard the idiom “Don’t put all your eggs in one basket”, and for good reason. Keeping all your funds in the same fund family can cause a lot of risk. You should aim to spread your assets in a variety of areas.
- Stocks are not the only investment option – If you’re thinking just stocks then you are mistaken. There are other options out there such as real estate funds, fixed income funds, international funds, etc. Having this variety mitigates you from the risk of losing all your assets at once.
If you have taken care of the fundamentals, you have won half the battle. Once you have identified your goals, objectives, and things that you should keep your watch on, you should be well on your way to making your money work for you.