Chapter 15 : Learn How to Choose Right Mutual Fund Scheme

How do you pick the right restaurant when you go out for a meal? Usually, you’d consider what you feel like eating. Then you’d consider the budget, the reviews people have given for the restaurant or your previous experience with it. Keeping these in mind, you’d probably choose one that would satisfy you the most on a given day. If nothing really appeals to you, you might just end up eating at home!

Choosing mutual funds to invest in can be approached a little like that.

Mutual Fund scheme selection in various scenarios

Let’s dig a little deeper and consider different scenarios.

1. You want to invest in the best

If you want to invest in the best funds that generate long-term wealth, a good approach would be to invest in equity funds that pick the highest-quality stocks.  Look for funds that invest in large companies with a good historical track record. Such funds are likely to provide steady returns over a long period and tend to be less volatile during rough markets.

• Large cap or blue-chip funds are good options.
• Consider investing via the SIP route since they are equity funds.
• Aim to invest for at least 5-7 years.

2. You are a conservative investor but want to invest in equity

A conservative equity investor wants equity exposure but also wants to minimize downside or risk protection. If you are one of those investors, then you should look for an equity fund with relatively stable returns.

• Hybrid or balanced advantage funds that give you stable returns along with balanced risk could be a good option.
• Index funds would be a good choice. The advantage of an index fund is that they replicate an index, so you can keep an eye on the benchmark’s performance to understand how your investment will likely turn out.
• Large cap funds are also an option, given that they usually invest in top-quality stocks.
• Once again, it is best to choose the SIP route for these equity investments.

3. You want to invest money for the long term

Equity mutual funds give the best returns over a long term. However, they are still prone to market volatility. This is why even when investing in the long term, you need to consider your risk appetite.

• Mid-cap, small-cap, sectoral or thematic funds are good options if you have a high-risk appetite and the ability to tolerate high volatility in the short term. They are likely to give good returns in the long term even if they fluctuate in the short term.
• For a slightly more conservative equity investment, choose a large cap or index fund. 

4. You want to create wealth and are willing to take risks for it

Investors who have high-risk appetite and a thirst to generate high wealth are identified as aggressive investors. If you identify as one of them, then you need to invest in funds that will meet that goal. But, the flip side with these is that there is a possibility that the fund may not perform to your expectations in the short term. This is why it is better to invest in these funds in the long term.

• If you are willing to take risks, then mid cap or small cap equity funds are your best bet.
• You can also choose to invest in sectoral or thematic funds.
• Once again, either choose the SIP route or be confident enough to time the market with a lumpsum investment.

5. You want to invest for your child‘s higher education

If you are a parent looking to invest for your child’s higher education with a timeline of about 10 years or more, then equity funds should be your preferred route. You have enough time to grow your money and are willing to take short-term risks. Equity funds beat inflation and can help you meet rising costs in the economy.

• Choose a large cap equity fund for tried and tested results.
• Solution-oriented schemes for children’s higher education is also an option.
• Choose the SIP route to build the corpus over a period of time.
• You can then switch to an arbitrage fund or a liquid fund about 1-2 years before the goal, i.e. before your child has to take up education.

You can use the TIP (Target Investment Planning) feature on ICICIdirect.com to accumulate and plan for your financial goals.

6. You want to invest for your retirement

If you are thinking of retirement planning early, say with 25-30 years of time to build a retirement corpus, then equity funds should be your go-to option. Retirement planning usually involves accumulating a corpus large enough to maintain your lifestyle post-retirement.

• Start with investing in large cap funds or retirement-oriented schemes.
• Closer to retirement, you can switch to a liquid fund, say about 2-3 years before your goal. This will help you protect your capital in case of an unexpected fall in the equity market before you retire.

7. You want to invest a lumpsum amount

If you have just received a bonus payment, a gift or made some cash from sale of assets and want to invest in a mutual fund, then you may not be able to time the market. In such cases, equity funds may not be the best option.

• Liquid funds or certain debt mutual funds are a good option for lumpsum investments when you cannot time the market.
• If you know the market is low, then you can choose an equity fund of your choice.
• Another approach to take is to invest in a liquid fund and then transfer to another equity fund on a periodic basis using the Systematic Transfer Plan option.

8. You want to invest your retirement corpus and also withdraw a fixed amount periodically post-retirement

If you have already reached retirement and want to continue to stay invested in mutual funds, you can use the Systematic Withdrawal Plan for regular income. SWP allows you to withdraw a fixed amount periodically from your accumulated mutual fund corpus.

• Since you need some stability, short-duration debt funds are a good option to get stable income after retirement.
• Balanced funds may also be worth considering if you can handle a little more risk.

There are many other scenarios under which you could invest. You could be saving up for travel, which is a short-term goal. A short-duration debt fund or a liquid fund can help you meet short-term goals. You may want to save for a house down payment in future. Equity mutual funds are good options for a 5-7 year time horizon.  The best approach to take is to list down your goals, risk appetite and investment horizon before making an investment decision.

9. You expect a continuous fall in interest rates in the near future

A falling interest-rate scenario means that the debt market becomes attractive. Older debt instruments issued at higher interest rates will become more attractive and hence, debt funds are likely to do well.

• If you are expecting interest rates to fall, you should choose a debt scheme that invests in high duration instruments.
• You can choose a Gilt fund if you don’t want default or credit risks.

10. You are unsure about the interest rate cycle

If you do not understand the market or are unsure about interest rate cycles, then investment in mutual funds, especially debt funds, can be tricky. However, if you still want to invest in debt mutual funds for better returns, there are some options.

• Choose a dynamic bond fund if you can’t keep up with interest rate cycles. These funds change their portfolio according to the interest rate cycle.

Summary

• Before making an investment in mutual funds, consider the following:
  • Your investment goal
  • Your risk appetite
  • The time horizon for investment
  • After deciding these, choose a fund depending upon:
    • Its investment style and strategy and how it matches your own goal
    • The fund’s performance history
    • The fund manager’s track record
    • The expenses associated with the fund
    • Equity investments are ideal for long-term investments. Choose an SIP route for equity mutual fund investments.
    • Liquid or short-duration debt mutual funds provide more stable returns. You can choose these for lumpsum investments.
    • Solution-oriented schemes for retirement or your children’s education can be considered for specific goals like that.
    • After retirement, SWP mutual fund option in a debt fund or a balanced fund can provide steady post-retirement income.

With this chapter, we come to the end of mutual fund basics. You should now know what mutual funds are, the different types of mutual funds and how to choose the right fund and mode of investment. In the advanced lessons, we will delve into how to evaluate mutual funds in details, look at some commonly-used methods and formulae for calculation and understand risk evaluation better.