Over the years, mutual funds have become one of the most popular forms of investment owing to their flexibility, convenience and the plethora of choices available. The numerous options also bring with them the complexity of choosing the right mutual fund. Before picking a mutual fund, you need to analyze the following parameters:
- Investment objective: The first and foremost step towards selecting and investing in a SIP of mutual funds is to understand your client’s investment objective. Why is he making the investment? Is it for fulfilling a short-term or a long-term goal? What kind of risk can he take with this investment? If he has a low appetite for risk, then it is ideal to invest in a debt fund through a SIP. If however, he is an aggressive investor, equity funds offer a promising rate of return.
- Costs: Evaluate all the costs that he may have to incur like exit loads (if any) which are charged when investors exit the investment prematurely. Also look at the annual recurring charges like the expense ratio as these costs eat into your client’s returns.
- Portfolio turnover: You need to monitor the fund’s portfolio turnover for the best SIP, i.e. the percentage of the portfolio that the fund manager changes through sales and purchases every year. A higher turnover results in higher costs (brokerage, taxes, etc.) at the fund level, which will ultimately be borne by the investors thereby reducing the rate of return.
- Diversification of assets: Three broad categories of mutual funds are equity, debt and hybrid funds (which invest in both equity and debt). In order to diversify your client’s investments and reduce risk, you can invest his corpus across different asset classes via mutual funds. Also, even if you are recommending an equity fund, investments can be made across different categories like large-cap, mid-cap and small-cap. This provides diversification benefits, stability from large-cap funds and growth from small and mid-cap funds.
- Quality of the fund management: It is important to invest in a fund that has a strong system and is process-driven rather than a fund that relies solely on the expertise of a ‘Star Fund Manager’ when you pick the best SIP to invest. However, it is also prudent to look at the fund manager and his or her track record.
- Assets under management: You need to be aware of the size of the fund as too small a fund will not be able to explore all investment opportunities while too big a fund becomes difficult to manage.
As with all other investments, even the best mutual funds scheme for SIP come with their own risks. However, if you conduct proper due diligence by following the pointers mentioned above, risks can be contained and your client’s investments can achieve tremendous returns.