How to choose the best (for you) mutual fund?


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How to choose the best (for you) mutual fund?

Postby executive_2010 » Mon Jan 05, 2009 5:46 pm

How to choose a mutual fund?

Before I attempt to answer this million $ question, first you must decide for yourself what you want from your savings. Ask yourself -
How much return p.a. do I desire?
How much risk am I willing to take?
How long do I plan to stay invested?
Why do I need this much return? OR
What am I going to do with my investment when it matures?

And you must be realistic while formulating answers to this question. For example, if you expect 30% returns, you must be comfortable with the risk of -10%. That is, you must be OK if your loose 10% of your money after 1 year. The risk reduces considerably if you keep your aim low. For example, if you want 8% return, the risk is practically zero and the answer is obvious - National Savings Certificates or Govt. bonds !!! If you desire 15% return, you might put half the money in a fund that invests in top cap companies like Infosys, TCS, Maruti, Tata motors, State Bank of India, HDFC etc, (the companies that would practically never go bankrupt) and remaining amount in Government securities and your risk would be less than 5%.

I personally do not like those so-called "balanced" or "low risk" mutual funds (MIPs). I instead suggest direct investing in risk free Govt. saving schemes and the surplus amount in equity mutual funds. Reasons -

1. Tax treatment of equity schemes is more favorable.
2. Why trust somebody else, if you don’t want to take enough risk?
3. Investing in Govt. schemes is easy as opposed to dealing with stocks. All it takes is a visit to the nearest post office.

So I would mainly discuss the "high risk" or pure equity funds here. Normally people tend to just look at the past returns in the prospectus, and choose the one that gave highest returns. Investing is not simply choosing the one with highest returns. Consistency matters. A good equity fund must have yielded about 15% return over past 5 years, inline with the market. And one should also read and understand the fineprint, which clearly says -
"Past performance does not guarantee future performance"

Investing is all about predicting the future, and let me tell you - nobody on earth can predict the market’s short term (6 months) performance accurately. So, if you are investing in equity mutual funds/stocks your investment horizon must be at least a year far. Do not dream of getting rich quick. If that’s what you want, buy a lottery ticket instead!

Look at the portfolio of the fund you plan to invest in and just think for yourself : Will these companies make good profit next year? For this, you must be aware of business news about those companies, and ideally speaking, you must have studied the balance sheets of all those companies. But in practice, this may not be possible and just a general idea about those companies is sufficient, unless you are investing a large amount.

That reminds me of another important point -
The total assets with your fund must be over Rs. 1000 Crore. This ensures that the mutual fund is truly "mutual" and is not under influence of just a few rich investors.

And lastly, credibility is of highest importance. There have been many mutual fund scams and one should never fall prey to unrealistic claims made by your broker/consultant or the fund salesperson. Anything over 30% p.a. is rubbish. Stick with the large fund houses, such as SBI, HDFC, Sundaram, Reliance Capital, Franklin Templeton, etc.

Almost invariably, the salesperson would ask you to consider investing in the scheme which has the highest NAV on that day. I’m not saying that one must avoid investing in a fund if it’s NAV is high. If the fund suits your requirement, and you feel that it will fetch good returns, there’s no harm doing so. But, this way, you are violating the age-old principle of making money. Buy low and sell high. And you also reduce your "actual" returns from the investment, that is, if the fund declares a dividend of 20%, and you bought it when at the price of 15 Rs. (instead of 10) your actual return is only 13%. Dividend is always calculated on the face value of Rs. 10.

Tips on Tax saving funds

Postby admin » Thu Apr 15, 2010 8:27 pm

At the time of buying a fund, you have two options - Dividend payout and dividend reinvest. When a dividend is declared for a fund, the first pays out the money to your bank account, and the later buys the same mutual fund units worth the dividend money. For example, if you own 100 units of a fund, and if 20% dividend is declared, you get Rs. 2 per unit (each unit has a face value of Rs. 10), that is, Rs. 200 credited to your account in the first option. And, in the second, you get extra new units worth Rs. 200. The net effect is the same.

However, it is better to choose the dividend payout option in case of a tax saving fund. Here's why:

1. Tax saving fund has a lock-in of 3 years. The new units can only be redeemed 3 years after the date of their allotment. This means, if you buy a fund in 2007, and are hoping to cash in in 2010, you can only redeem your original units. If the fund declared a dividend in 2009, those new units can only be touched in 2012 (which is when the world is supposed to end ;) )!

2. Get some money back from the evil government. Let's say you invest Rs. 100,000 in March in a fund. You get a tax rebate on the full amount - Rs. 100,000. If luck is on your side, the fund might declare a dividend in the next month - say, Rs. 1 per unit. So, if you hold 10,000 units, you get Rs. 10,000 back. Thus, effectively you got a tax rebate on Rs. 1 lakh against an investment of Rs. 90,000. Yay!

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