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

03 May 2022

The question of how to start investing in mutual funds has numerous different perceptions, opinions, and myths around it. Often, reality gets buried while mutual fund distributors or advisors tend to provide you with their insight. Retail investors, particularly, are the ones who are likely to get lost in this maze. In this blog, we at Groww, seek to provide you with some of the key questions you, as an investor, should ask before making any investment in any of the mutual funds.

Question 1: What Is Your Objective for Investment and Does the Fund Fit Your Requirement? 

Finalizing your goal and/or objective is the first and most important step to beginning a mutual fund investment.  This includes your target amount, time horizon to complete the goal and your risk appetite. For starters, it makes sense to ask yourself what your objective is.

While it may seem straightforward, this is the step where the majority of investors go wrong and end up buying products that don’t truly align with their goals. Thus, it is better to ensure your objective falls in any of the following:

  • Growth 

    The strategy is aggressive and comes with a moderately high risk. Thus, it is more suited to individuals who are starting their investments at an early stage. Small-cap funds give high returns, but they come with a high level of risk as well, which can be suitable for an investor of a young age.

  • Capital Preservation

    The strategy is more suited to investors who are conservative and/or are nearing retirement. This ensures your capital remains safe and thus returns are comparatively lower.

  • Income

    This is best suited for investors who want regular income from the investments such as senior citizens. Check income funds with a conservative risk profile here.

Given the fact that no single investment can take care of all three objectives at a time, it is important that you determine which approach is best for you.

Question 2: What is the Average Annual Return the Fund Has Given in The last 10 Years?

It is advisable to check on the average returns generated by a fund over the long-term rather than just getting carried away with the short-term performance of the fund. Returns over a longer time period provide a better picture of fund stability, as it tends to cancel out any extrinsic performance due to market timing.

In addition, the fund’s historical performance during both up-market and down-market should be seen to get a holistic picture. Performing up-market is easier than constraining losses during the market. Thus, we believe an investor should spend some time understanding how the fund manager restricted losses during the down market, as it is the true test of active management.

Question 3: What is the expense?

The expense of managing a fund is determined by the expense ratio. An expense ratio is an important parameter that you should look at while selecting any mutual fund scheme. The expense ratio is the percentage of assets that go towards expenses such as brokerage, distribution, commission, etc.

Every time a fund manager churns his/her portfolio, a brokerage fee is paid which is borne by investors in the form of expense. Thus, a high expense ratio will affect the fund’s returns. Though the mutual fund’s total expense ratio has been capped by SEBI (the regulator in the Indian market), it is better to have a lower expense ratio as a lower expense ratio benefits in the longer term. Generally, a scheme with a high asset size has a lower expense ratio than that of a small-sized fund.

Questions 4: Will the fund provide tax benefits?

In India, Equity Linked Saving Scheme (ELSS) is a category of mutual fund that provides tax benefits under section 80C of the Income Tax Act. Thus, it makes sense for an investor to check if the fund shortlisted comes under ELSS or not.

While an investor definitely gets the benefit of tax saving by investing in ELSS funds, these funds come with a lock-in period of three years. Check other details sections of any fund in Groww to get an understanding of taxation applicable to the fund.

Invest in mutual funds

Question 5: Is It a Close-Ended Or an Open-Ended Fund?

It is advisable that you ask your financial advisor if the fund is an open-ended fund or a close-ended fund. Open-ended funds provide greater flexibility with respect to investment transactions (such as subscription or redemption).

On the other hand, a closed-ended fund generally comes with a lock-in period within which it is not possible to sell your investment in the fund. Typically an investor tries to book partial profit when the market has run up significantly to unsustainable levels. This redemption is allowed in the open-ended fund only.

Question 6: Who Manages The Fund?

By now you must have finalized on few names to invest in. Now that you’ve narrowed down your list of potential investments, it is time you check who is driving the fund from the front. Thus, the fund manager plays a pivotal role in fund management.

Though the fund management is generally process-oriented whereby the fund sticks to its investment objective, the fund manager still remains important, given their viewpoint counts a lot. You should check the overall experience of the fund manager and his team so as to ensure that your hard-earned money goes into competent and deserving hands.

We believe typically a fund manager with over 15 years of proven track record is well-positioned than any other fund manager. While it is undoubtedly true that past performance is no guarantee of future returns, having an established track record provides comfort in the minds of investors given the fact that the hard-earned money of investors will be at stake. With a past track record, an investor can fairly visualize what he/she should expect out of the investment over a different time period.

Concluding Remarks

Shopping for a mutual fund can be a daunting task given the plethora of options available in the capital market. Thus, it is important that an investor spends ample time analyzing the funds that are best suited as per their risk profile and objective.

It is important that an investor understands the nuances associated with each of the funds selected for investment and analyze the pros and cons before he decides to start investing in mutual funds. While you can use our fund explorer which provides you with a comprehensive picture of each fund, you can also choose to write to us.

We are Omnipresent across social media and all it takes is just a “Hi” to start your financial journey with Groww.

Happy Investing!

Disclaimer: The views written in this blog post are the author’s alone and does not reflect that of Groww.

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