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Ask Yourself These 3 Questions Before Choosing a Mutual Fund

Updated on :  

08 min read.

Picking the right mutual funds that meet your goals is extremely important. But, sometimes this can be a hard decision to make. We have covered the following in this article. In this article, we will cover –

Why are multiple fund choices not always a good thing?

Having several options is not favourable every time. Studies have shown that the best decisions are made when there are fewer options. The paradox of choice is what supermarkets thrive on. They give you so many options to pick from that you end up buying more than what you need–often to try things out.

On a similar vein, the mutual fund investor is also spoilt for choice. But when it comes to mutual fund investments, an investor cannot afford to “try” funds out. There is no room for errors here. The performance of your investment is directly linked to the goals you are investing for. It is your hard-earned money that you are putting into a fund, which is why picking the right fund is of utmost importance.  

Choosing a fund – should you go by personal needs or market trends?

But choosing the right fund is not easy. Even seasoned investors struggle when making a choice. It is understandable for a new investor to be overwhelmed by the entire process. There are just way too many funds to choose from. That being said, choosing your first mutual fund has more to do with your self than the fund options in front of you.

What should I ask myself before I pick a fund?

When you are faced with the decision of choosing a mutual fund, ask yourself the following questions and base your decision on the answers you come up with.

Question 1: What am I investing for?

You will make better investment decisions if you are investing for a specific purpose or goal. This goal could be the purchase of a new car or house, saving for your child’s education or a vacation abroad. Even investing in a mutual fund to be able to save and earn better returns than a savings account or fixed deposit can be a goal. With a definite purpose in mind, you can make an informed choice.

Question 2: What is my investment horizon?

On a vast level, the longer you have to invest, the more risks you can take. If your investment horizon is just a few years away, you should probably take fewer investment risks. This is why the number of years is an important metric to consider when choosing a mutual fund.

Question 3: Is my goal negotiable or not?

A vacation abroad can be a negotiable goal in the sense that if you don’t have the adequate amount, you can push it further by a few months. But something like a child’s college education is a non-negotiable goal. You have to pay the fees at a specific time, and that is something you cannot delay.

What fund types should my portfolio contain?

Once you have the answers to these three questions, you will be able to decide on the type of fund you need to invest in. Remember to follow the mantra below:

a. For non-negotiable short-term goals, you should opt for debt mutual funds.

b. If the goal is non-negotiable, but a few years away, you can begin investing in an equity fund and gradually book profits as you come nearer to your goal.

c.For negotiable long-term goals, you can consider equity funds because they are best placed to give you higher returns.

d. If the goal is negotiable but short-term, a balanced fund would be the best option.

Your Personal GoalYour Time Limit for Achieving the GoalYour Portfolio
Non-negotiable (home loan payment, children’s education)ImmediateDebt Mutal Funds
Non-negotiableFew yearsEquity Funds
Negotiable (buying a house, world tour)Few to several yearsEquity Funds
NegotiableImmediateBalanced Funds

Once you have figured out the type of mutual fund you need to invest in–equity, debt or balanced–you should choose a fund that has a long history of doing well over different market cycles.

This means that a fund that has weathered different economic conditions in the past would be a more sound bet than a new fund that doesn’t have a history to speak of. Of course, past performance does not guarantee future returns, but it is a good indicator when making a choice.

A simple way to do this is to look at the top-performing funds of a category over various periods like one year, three years, five years and ten years. Among these funds, choose the fund that appears in the lists for most periods. You can also take the help of mutual fund expert to give you fund suggestions based on your goals and investment horizon.

This is how you can simplify the process of choosing a mutual fund. Remember to be honest to yourself when you answer the questions mentioned above. You will make a better choice when you know your investment purpose and goal.

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