How do I screen mutual funds?

To the novice investor, mutual funds provide a convenient way to start investing before diving head first in the world of investments. Did you say why? Read on..

• You don't need to know which stocks to invest in? Fund manager chooses, buys, sells stocks (or other securities depending on fund category) on your behalf.
• You don't have to worry about when to start investing. By the way, answer to that question is NOW, whatever the market condition may be. Decide on your money goals and start investing accordingly.

You can either buy a fund in lump sum or in periodic installments. The benefit of making  periodic installment is multiple fold.

1. You can start as small as Rs 500/1000 a month. Most funds have that as the minimum investment amount a month.
2. Second an even more important, you never have to think of when is the right time to make an investment. For ex. if you do an SIP for 3 years, you make 36 investments and varying prices throughout the 3 year period. In the end, you get an average price which makes it unnecessary to be able to time your purchases which arguably is temptation but 99% fail at and 1% are not lucky consistently
3. You can be at peace without thinking of where the stock market is going during these 3 periods.

It is of utmost importance that you never stop an SIP due to market conditions. If the market keeps falling and you stop, you end up buying units only when they were costly. If  you stop your SIP when the market is rising, you still lose out on compounding benefits.

Any money invested in fixed deposits, savings account and even real estate (unless your lucky and catch a rising wave), you hardly ever get a good return that can conveniently beat inflation. For the record, a fixed deposit giving 7.0% with inflation at 6% gives you about 5.5% after tax so your purchasing power is effectively decreasing. 

Due to these reasons and given the compounding benefits of an investment, it's almost a crime not to be investing in SIPs and keeping most of your savings underutilized (inflation is always catching up on it so doing nothing is still losing).

Preparation: before starting to look for funds to invest in, decide on the following things:

• What is your investment horizon? Do you want to invest for 5, 10, 20 years? if you are investing for long term look for equity funds and liquid or debt funds if you are investing for 3-5 years.
• What are your financial goals? Children's education, buying a house, world tour in x number of years.
• What is the amount you can invest every month?
• What is your age? helps you decide how much risk you want to take. A general rule of thumb is to subtract your age from 100 and invest the returned amount in equity and rest in safer option. Hardly anyone lives up to 100 these days so I'll say better do a +10 in your subtracted amount.
• Divide the total amount in 3-5 blocks so as not to overly diversify and look for that many funds to invest in. Always choose one of the fund as a tax planning one. Provides tax benefit under 80C as well as they are very good performing.

Q. Where to search for funds?

A. valueresearchonline.com is a vary good place. in fact, it's the only one I explore since it has all the data you want.

Selecting a fund:

• Decide on the category you want to invest in. If you are new start with an ELSS (tax planning benefits), a balanced fund and one large cap. The latter two are conservative choices. Avoid the theme specific funds unless you are an advanced investor who has good understanding of market and you are betting on a given sector doing much better in future. Also, if you are starting late in your life, focus more towards balanced and debt funds. While balanced will still give you equity benefits, it will carry lesser risk for you. Debt funds are mostly safe and somewhat closer to an FD if you invest at least for 3 years in which case they return better than fixed deposits due to the indexation benefits. Index funds are also a good option if you want to invest in the stock market without taking much risk
• Open or closed ended: Supposedly closed ended are to give better returns but it's not always true so always choose the open ended ones as you can take out your money in case of an urgency
• Among equity funds, you can choose between something that mainly invests in large companies (relatively stable), mid-small cap (riskier but come with better profits in favorable times) or a dynamic fund that invests in all 3. Choose as per your risk preference.
• Look for the top 10 performing funds in the category that you want to invest in. Get the top 10 funds by best returns in last 5 years. Take the ones with best returns
• Exclude the funds which have not been around for 10 years. This is to weed out funds that may have started during a favorable time for stock market and show superior return as a result. A 10+ year old fund is very likely to have seen ups and downs of the market. Choose a few funds that satisfy the criterion from the 5 year return comparison
• Compare the 10, 5, 3, 2 and 1 year returns of the chosen funds. Look for consistency. Make sure that the return is not falling much in the last 1-2 years. Also look for returns since inception. This is a good indicator if the fund has been doing well consistently
• Check the funds  that are managing a significant amount of money. There may be some funds  which manage only 50-100 crore which is pretty much nothing when compared to some large fund houses. Pick the large ones instead as there performance is more proven
• Check for the expense ratio of the remaining funds. Expense ratio is the amount that goes out as fees each year from your yearly assets. These vary from 0.75 to 2.5+. These numbers may look small but if you invest over a long period of time, they take a huge chunk out of your investment so be careful to choose something that doesn't charge very high expense ratio
• For the chosen funds, compare the risk grade and choose the one that suits your risk appetite given the returns expected
• Check to make sure the fund manager has not changed recently. it may be possible that a high performing fund manager has moved on and the new one may not be as good, although unlikely for a well performing fund
• Check the exit load, this is the amount you pay if you exit a fund before one year period. If your investment is long term so don't worry about it much. Most funds are providing the same 1% exit load but do check before signing up
• Don't obsess over fund rank in the category. A higher one may not suit your need based on above criteria
• Always monitor turnover of a fund. A fund with higher turnover sells and buys its portfolio more than the one with lower turnover. This means it needs to get more return to beat a low turnover fund and so harder its task
• Always go for a step-up SIP. It will make a huge difference to your final corpus

Important Note: There are two options on each fund. Direct or Indirect. Direct gives about a 1% higher return than indirect. If you go with indirect, some broker (one you are buying the fund from) is getting commission out of your each investment installment. This option should only be taken when the bank/mutual fund house that you are buying the fund from provides detailed information and guidance on how your fund is performing.

Making the investment:

If you are going for the investment option, your fund house/broker will do the needful for you. If you are buying a direct option then google and find out the website of the mutual fund, register for an account and search for the fund that you want. Select the SIP option and make sure to choose the DIRECT option.

Monitor your fund performance once in 4-6 months and see that it is not doing too bad. It's usual for funds to give negative returns in very short term. Only change if the fund is not doing well for 1-2 years compared to others in its category.

Monitoring: Something I noticed later, DO NOT change funds if you don't see expected performance in 1,2,3 years. A long performing fund will always have ups and downs (part of equity volatility). When you see under performance, look for reasons that may have caused it. If the reasons are temporary, there is no reason to abandon your selected fund. On the other hand, if the fund manager has changed and the new fund manager invests in completely different style, you might want to switch out.

Disclaimer: I favor equity due to the higher benefits. It does also come with the extra risk.