Why You Should Choose Your Mutual Fund Carefully
Like many other things, your investments also come with multiple options. Once you have decided that you are planning to use mutual funds to meet your long-term and short-term goals, you will realise that you have more options than you thought. According to the latest data from the Association of Mutual Funds in India, an industry body, 44 mutual fund asset management companies exist in India. They offer over 2500 mutual fund schemes for you. If you work with a financial advisor, you can identify the schemes that are appropriate for you. Several factors are involved in that selection, though.
Why all mutual funds are not for you?
Mutual fund schemes are launched to create wealth. They include two factors. The first is capital protection in the short term and wealth generation in the long term. Equity assets need adequate time to create any meaningful corpus (for retirement or a child’s education) for you. If you are working on short-term goals, you must not allocate more money to equity assets. The volatility in the stock market can lead to a loss of capital when you need it the most. Mutual fund investors are commonly willing to buy many schemes. However, buying too many mutual fund schemes would create a problem of diminishing returns and over-diversification. You may succeed in protecting your capital but may not be able to generate the desired long-term wealth. You must focus on a few solid-performing schemes in multiple asset classes based on an asset allocation formula suitable to your profile.
If you are unaware of your risk appetite, you may pick up mutual funds that do not suit you. For example, you may buy too many sectoral equity schemes and realise that the market downturn has eroded the value of your investment. Investing in a sectoral fund brings all the risks associated with that sector to your investment. Based on fundamental and technical factors, share prices in that sector would react to events that only affect companies in that sector.
Similarly, inflation affects the performance of debt mutual funds. Buying a debt fund scheme for long-term wealth creation makes no sense as you do not know the future inflation trend. Your returns would be lower than the inflation rate in the economy.
What mutual fund is right?
Among 2,500 mutual fund schemes, you need to choose those that suit your financial goals. You should align your choice with your financial goals that could be short-term or long-term. Accordingly, you need to make the proper asset allocation. That is a function of your risk appetite. You must understand that by considering your ability to create a monthly surplus. It is the money you do not need immediately. When you reach an amount every month you are comfortable saving; you can then allocate it into equity, hybrid or debt mutual fund schemes. You can do that appropriately if you work with a professional financial advisor. Most people read up on a ‘DIY’ method by watching online videos. Thumb rules like ‘100 minus age’ determine the allocation of equity mutual fund schemes. You can allocate more towards equity schemes and less towards debt at a young age. Your ability to withstand shocks is much more than when you are old. That means your risk appetite decreases with age, and so should your equity allocation. The ‘right’ mutual fund is related to you clearly defining your financial goals. For example, if you are in your 30s and retirement is your long-term financial goal, you must actively allocate money to equity assets.
Similarly, if you wish to create a corpus for the down payment for a home loan, you must stay cautious and allocate that to the fixed income category. If you are confident about your future income, you can own equity schemes across large, mid, and small-cap funds. However, if you are not confident about your income, you may want to opt for multi-asset funds.
Conclusion
Keeping a simple asset allocation plan will help you avoid wrong choices. Choosing a suitable mutual fund scheme can be done with careful research or help from professional advisors. Investing based on informal advice or hearsay could hurt your investments. Get a professional to help you determine an appropriate asset allocation and select schemes that suit you.
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