How to Choose Mutual Funds for Investment in India?

Mutual funds are a highly popular choice of investment in India, and the risks and rewards offered on these options are based on your financial plans. Nevertheless, since there are so many possible choices, it can be tough to pick the best one when it comes to investing in mutual funds. So, how to select mutual funds for investments in India? This blog will help you navigate the proven factors to look for when evaluating mutual funds in India.

Types of Mutual Fund Schemes

Mutual funds can be broadly classified into three categories: Equity Funds, Debt Funds, and Hybrid Funds.

1. Equity Funds

Equity Mutual Funds are the most common asset class in the long term. The returns are not guaranteed, but there is a potential for higher returns as compared to other investments.

Various equity funds:

1. Large Cap Funds invest in the 100 top companies based on market cap, which tend to have more stability and provide more consistent returns than other investments.

2. Mid-cap funds invest in companies 101-250 based on market cap, which represents a balance of risk and return.

3. Small Cap Funds invest in companies ranked after 250, which creates a more risky investment, but certainly the opportunity for a higher return.

4. Flexi Cap Funds invest a minimum of 65% of their funds in equities and generally diversify across all market caps.

5. Index Funds build a portfolio that matches the performance of a particular stock market index.

6. Sectoral/Thematic Funds build a portfolio of one or more specific industries.

7. Equity Linked Savings Schemes (ELSS) are funds that allow tax benefits if leveraged within the confines of the Income Tax Act 1961, Section 80C, which creates an attractive investment for a tax saving investment opportunity.

These are all forms of equity funds that try to provide opportunity based on an individual's investments.

2. Debt Mutual Fund:

They may be considered for conservative investors who aim to prioritize regular income. These funds typically invest in bonds:

1. Government securities

2. Corporate bonds

It offers lower returns compared to equity funds but with reduced risk levels. Examples of debt funds include:

1. Overnight funds

2. Liquid Funds

3. Dynamic Bond Funds

4. Long-Term Income Funds

These are relatively feasible investment options for those seeking steady returns.

3. Hybrid funds:

The hybrid mutual fund is a mix of both:

1. Debt mutual fund

2. Equity mutual fund

This fund aims at balancing both returns and risks. It helps in diversifying your portfolio Examples of hybrid mutual funds are:

1. Conservative mutual fund

2. Balanced mutual fund

3. Aggressive mutual fund

4. Equity savings fund

This is suitable for investing aiming for moderate risk with steady returns.

Direct or Regular Plans

There are two types schemes available for mutual funds: Direct and regular

In a direct scenario, investors have the option to buy the required NAV units through the concerned fund house. On the other hand, in the regular option, units have to be bought through the concerned commissioner or broker.

A key distinction is that returns are slightly better in the direct Mutual Fund as there are no commissions. These commissions vary between 1-1.25%, depending on the asset management company and brokerage.

When it is a regular Mutual Fund, the asset management company (AMC) pays commissions to the brokerage to attract clientele. Consequently, this takes away from principal investment and lowers the total returns received.

How to choose mutual funds?

Here's a guide on how to choose the best mutual funds as per your requirements:

1. Goals

When deciding how to choose mutual funds, you want to have a clear investment objective. If you do not have an objective, you may be inclined to sell because of small fluctuations in the market.

Your investment objective may be short-term, such as buying everyday items, putting a down payment on a house, or taking a trip out of the country. Or, your objective may be long-term, such as planning for retirement or for a child's college expenses.

A clear investment objective will help you determine what type of mutual fund is suitable for you.

For example, some investors want mutual fund investments for capital appreciation; others may want the benefit of investing in a mutual fund that offers tax benefits. Ultimately, the right mutual fund depends on your investment strategy and financial goals.

2. Risk

Risk arises from not knowing what you are dealing with.

When investing in an equity mutual fund, it is susceptible to market risk, meaning your equity-based portfolio could be volatile in the short term. The return on capital could also be considerably higher than other fund types. It could be suitable for long-term aggressive investors.

Debt mutual funds are relatively stable. Returns would likely be lower than equity funds. These would fit more conservative investors. You can refer to the table below to assess your own risk profile and time horizon to identify the mutual fund brand you should consider for yourself.

3. Liquidity

When deciding on how to select mutual funds for SIP, liquidity is a key factor to consider. You need to think about when you might need your investment. If you need the money soon, equity funds might not be the best choice because they might not give you the returns you expect.

If you can keep your investment for a year or more, then equity funds can potentially generate good returns. This is because compounding works best when you leave your money invested for a long time. If you want to access your money quickly, liquid funds are a better option.

4. Investment strategy

While deciding how to choose the best mutual fund a vast number of people neglect investment strategy. However, the investment strategy is a critical part of our investment portfolio's success.

An investment strategy (or investment process) assists fund companies in making investment decisions. If a fund company's strategy does not align with your investment philosophy, there is a potential conflict of interest, and a continued misalignment may force you to exit your investment when the prices are not favourable.

5. Fund performance

Fund performance should be evaluated over a reasonable time period so that the investment has been captured in different cycles of the market. This would help ensure there are some consistent returns over the time period studied.

If the fund does not outperform its benchmark historically over three, five, seven or ten years, it would be rational to presume that the fund is not an acceptable investment.

When assessing fund performance the individual fund manager or management team should be assessed as well. Having a strong, stable, experienced Fund management team with a reasonable average tenure and historical performance would benefit many investors.

6. Expense Ratio

The expense ratio is an important factor to consider when choosing mutual funds. It's basically the fee that fund managers charge to manage your investments.

A lower expense ratio is generally better for investors. Even though the percentage might seem small, it can add up over time and impact your overall returns. A higher AUM (Assets Under Management) often means a lower expense ratio, but it's not always the case. You should always compare expense ratios across different funds.

7. Entry and exit load

Entry load is a fee that fund houses charge directly from investors. It has been removed by most fund houses.

Exit load, on the other hand, is what the investor has to pay when he exits from a mutual fund scheme. This is charged only for a brief period after the investor has invested in the scheme to discourage short-term exit and immediate cash outflow from mutual fund houses.

You should also monitor mutual fund schemes that have zero or minimum entry and exit load.

8. Taxes

Mutual funds in India are taxed based on the type of fund and the holding period. Here's a breakdown:

1. Equity-Oriented Mutual Funds:

• Short-Term Capital Gains (STCG): If held for less than 12 months, gains are taxed at 15%.

• Long-Term Capital Gains (LTCG): If held for more than 12 months, gains up to ₹1 lakh are tax-free. Gains exceeding ₹1 lakh are taxed at 10% without indexation benefits.

2. Debt-Oriented Mutual Funds:

• Short-Term Capital Gains (STCG): If held for less than 36 months, gains are taxed as per the investor's income tax slab.

• Long-Term Capital Gains (LTCG): If held for more than 36 months, gains are taxed at 20% with indexation benefits.

3. Dividends:

• Dividends received from mutual funds are added to the investor's income and taxed as per their income tax slab.

Conclusion

In India, investing in mutual funds can be a great option to accomplish your financial goals, although it could be challenging to choose the right mutual fund. However, by considering your goals, risk profile, and fund performance, you can easily select mutual funds that fit your financial needs.