6 Questions You Must Ask Before You Invest in a Mutual Fund

08 March 2023
5 min read
6 Questions You Must Ask Before You Invest in a Mutual Fund
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There are several misconceptions, viewpoints, and misunderstandings about how to begin investing in mutual funds. While mutual fund distributors or advisors often give you their expertise, the truth frequently gets hidden. The ones most likely to become lost in this maze are retail investors.

Choosing the investment that best meets your financial objectives is not simple. So many alternatives are available, and having too many options might provide difficulties. However, you can make selecting the best investment simpler in various ways.

One of these is posing a few fundamental inquiries to yourself that may help you understand your investment requirements and help you make a well-informed choice.

In this blog, we at Groww are attempting to provide you with some of the important questions you, as an investor, should ask before placing any investment in any mutual fund.

6 Questions to Ask Before You Invest in a Mutual Fund

1) What is My Investment Objective?

The initial and most crucial stage in starting a mutual fund investment is to decide on your aim and objective.

This contains your desired sum, projected completion date, and level of risk tolerance. It seems reasonable to start by asking yourself what your goal is.

Although it can appear simple, this is when most investors make mistakes and purchase things that are not in line with their objectives.

So, it is best to make sure that your goal fits into one of the following categories-

Growth

The tactic is aggressive and carries a comparatively high level of risk. As a result, it is better suited to those who are just beginning their investment careers.

Capital Preservation

Those who are cautious and close to retirement are better suited for the strategy. This protects your cash and results in relatively lesser returns.

Income

Senior folks and other investors who desire regular investment income should use this strategy. Check income funds with a conservative risk profile here.

(NOTE: No investment can address all three goals simultaneously, so you must choose the best strategy.)

2) What is My Level of Risk Tolerance?

Your risk tolerance is your capacity to emotionally and financially handle a loss from an investment. Your age and financial responsibilities are two essential variables determining your risk tolerance.

Hence, if you are a younger investor in your 20s with minimal debts, you will have a greater capacity for risk than if you are in your late 40s, have a home loan that is past due, and have children who are in college. As a result, you can choose investment items that may offer greater returns but can result in volatility.

Conversely, if your risk tolerance is low, you would be better suited to investing in securities that provide more consistent returns.

3) Does the Fund Offer Tax Advantages?

Under Section 80C of the Income Tax Act, the Equity Linked Saving Scheme (ELSS) category of mutual funds in India offers tax advantages. So, it makes sense for an investor to determine whether or not the shortlisted fund falls under ELSS.

Taxes will undoubtedly deplete your investment, so choosing a more tax-efficient fund is another proven strategy to increase your returns over time. After researching, choosing a more tax-efficient fund will allow you to keep more of your future earnings.

So, the following factors precisely distinguish one fund from another in terms of tax efficiency-

Technique

A fund's investing strategy significantly impacts how tax-efficient it is; generally speaking, index-based funds are more tax-efficient than actively managed funds.

Turnover Ratio

This describes how frequently the fund trades, mostly related to its technique.

Proportions

The size and nature of the distributions influence a fund's tax efficiency.

4) Who Manages The Fund?

You have now reduced your list of prospective investments to a few funds, so it's time to consider who will operate each one.

The portfolio manager's abilities can significantly influence the success of a mutual fund. Therefore, investors should try to find out who is managing their fund and, more particularly, delve deeper and look at that manager's track record over the long term because of inconsistent results. Indeed, past results do not guarantee future success.

Because of this, investors are better off choosing a manager with a solid 15-year track record than one who had a great run in one year and then utterly tanked the following.

5) What is the Cost of Investing?

The expense ratio decides how much it costs to manage a fund.

When choosing any mutual fund plan, an expense ratio is an essential factor to consider. The expenditure ratio is the portion of assets used to pay for costs like commission, distribution, and brokerage.

Each time management rebalances its portfolio, a brokerage fee is paid, and investors are responsible for this cost. As a result, the fund's performance will be impacted by a high-cost ratio.

Although SEBI (the market regulator in India) has set a ceiling on the mutual fund's total cost ratio, having a lower expense ratio is still preferable since it offers longer-term advantages.

In addition, a plan with a significant asset size often has a lower expense ratio than a small fund.

6) Is My Knowledge of The Investment Sufficient?

Investors frequently choose investments while having little understanding of the subject matter.

Regrettably, making investments without enough knowledge usually nearly leads to bad outcomes. Hence, take this vital investment lesson from Warren Buffet and consider if you truly comprehend your investments.

If not, educate yourself so that, before investing your hard-earned money, you can decide on your selected asset's possible advantages and hazards.

Conclusion

In conclusion, choosing a mutual fund may be a complex undertaking with many possibilities in the capital market. The funds that are most suited for an investor's risk profile and objectives should thus be thoroughly examined.

When deciding to invest in mutual funds, an investor must be aware of the specifics surrounding each of the funds he has chosen and weigh the benefits and drawbacks. You can write to us in addition to using our fund explorer, which gives you a thorough overview of each fund.

Happy Investing!

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