6 Questions to Ask Before Investing in a Mutual Fund

Investing your finances in various investment products requires a lot of time and research on your part in being aware of the advantages, the risks and the drawbacks of every investment product.  

If you have decided to invest a part of your income into mutual funds, you will be alarmed by the numerous types of mutual funds that are readily available. When selecting a mutual fund, one needs to ensure that the product is in sync with their long-term goals as well as their risk preference. With thousands of mutual funds flooding the market, any investor would be left spellbound! 

In order to streamline the entire process, an investor can ask himself the six questions mentioned below, the answers to which, will help him/her find a mutual fund that is sync with his/her financial goals. 

1. What is your objective?

 Firstly, the important question which is overlooked and sidelined is- What are your investment goals and objectives?  What are your risk preferences? What is the investment timeframe you are looking at? 

As an investor, you have to ensure that your objective needs to be very clear. If you are a young investor and are willing to take a risk and aim at growth in the value of your investment, you can select a growth fund/equity fund. 

If you are on the conservative side or a retired individual you could consider investing in stable portfolio which protects your principal as well ensures a minimal return, your focus would be on preserving your capital.

 If you wish to have an income generation, you could opt for income funds, however, the tax conscious could avoid this kind of fund.  

2. What is the average annual return offered by the Fund in the last 10 years?

 As we are aware, many of the mutual funds have been in the industry for quite a few years. It is highly recommended that the investors must always enquire about the average annual return of the fund in the last 5-10 years and not just limit it to the last one year itself.  This clarity rules out the fluctuations and presents you with a better outlook of the fund, its performance over the years and what an investor can expect in future from the fund in terms of returns. For instance, a specific sector of mutual funds such as IT or Banking, might indicate a return of more than 60% for the previous year which could have due to various external reasons like elections, the budget, etc. However, this does not mean that the same return is guaranteed for the upcoming year. 

 3. What is the expense involved- what is its expense ratio? 

Once you have decided on your investment goals and the investment time frame, out of the choices that match your goals, you need to check the expense ratio of the fund. We would always love to keep our expenses at a minimum. Initially, the fee might appear to be a small figure, but in the long-run, adding up the fees might give you a huge amount in the name of expenses. This can have a huge impact on your investment portfolio. 

 What is an expense ratio? It is the fee an investor pays for the various costs involved in managing a mutual fund. This fee ranges between 1-2.5% and is taken out of your investment. 

 For example, in case a return of about 14% is earned by the mutual fund you have invested in, you will be eligible to only 11.5% and the 2.5% is the management fee. 

The direct plans offered by many Mutual funds are cost-effective and their expense ratios are approximately 50% less than the regular plans.  MoneyFront gives you the option to invest in direct plans making it very efficient for investors.   

4. Do you invest in a close-ended or open-ended fund? 

When you are selecting a mutual fund, make sure to enquire with your advisor if it is a close-ended or open-ended fund. An open-ended fund is quite flexible and you can sell it off if you feel you have achieved the desired return. On the other hand, a close-ended fund comes with a lock-in period wherein you cannot exit the fund during that period even if your fund has achieved the best of returns. Normally, lock-in periods are for 3 years. In case you decide to exit during the lock-in period, the exit fees might make you rethink your decision.   

5. Is the mutual fund beneficial on the tax front? 

Tax-efficient funds are the best way to boost your income and the best way to find a good fund is by research. In a mutual fund, the approach of investment used, the frequency of trading, the amount of distribution paid, helps in making the fund tax efficient. The Equity Linked Saving Scheme (ELSS) lets an investor deduct the invested amount for the purpose of saving tax. This is as per the limit laid down by Section 80C of the Income Tax Act.   

6.  Who manages the fund? 

The success of any mutual fund is also dependent on the fund manager.  A fund manager is the person who manages the investment portfolio of the clients. For instance, a fund manager will either buy or sell an investment, at the right time, as per the goals and risk tolerance levels of their clients and monitor the portfolio. You must enquire about the experience of the fund manager.  You must have answers to questions such as- Has the fund manager managed any other funds? How successful have the funds been? What is the style of investment?  In addition to this, try and understand the stability of the fund management over the years. 

 In short, an investor must be aware of his investment objectives, risk preferences, time-frame of investment and then find a fund which matches his goals. Investments are based on speculations, assumptions, opinions, beliefs, etc., which can be quite chaotic and this might lead to the investor getting diverted from his investment goals. Investment is not a simple process and requires good amount of time spent on research, which will help you make the right choice. 

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Pratik is an MBA from IBS business school – Mumbai, with dual specialization in Marketing and Finance. He is driven by passion for markets and loves to analyze client portfolios with a long-term approach. He believes in the principle of asset allocation and diversification to maximise client return following a risk-based approach. Managing risk comes naturally to him, owing to his prior work experience with worked for ICICI Prudential Life Insurance Co. Ltd.