Your Money: Smart tips for selecting the right mutual fund

Before selecting a mutual fund, it is crucial to identify your financial goal. Once you have identified your goals, you may select the appropriate mutual fund product in sync with your short or long-term financial goals.

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Expense ratio
The expense ratio is what a fund house charges its investors for various costs incurred for managing any mutual fund scheme. For example, one fund has an ER of 0.99%, which means that for every Rs 100 invested in this fund, you’ll have to pay Rs 0.99 to the fund house, and therefore, your final returns may be lower by that extent. You need to see your gains against the fund’s ER. It is built into the fund’s unit price, which is its NAV. There is also a difference between regular or direct plans of the same fund.

Tax implication
Tax liability plays a significant role when you select a mutual fund product. The tax rate is based on the category of mutual fund and investment horizon. For example, an investment period of more than one year is considered long-term when you invest in equity mutual fund products. You have to stay invested for more than three years to come into the long-term investment category in a debt fund. Short-term capital gains (STCG) in equity mutual funds attract 15% tax, and long-term capital gains (LTCG) are tax-exempt up to Rs 1 lakh in a financial year; the LTCG above this threshold is taxed at a 10%. In debt funds, the STCG is taxed according to the applicable slab rate of the investor, whereas LTCG is taxed at a 20% rate along with indexation benefit.

Funds to invest
You should prefer such funds that fit your criteria, such as return consistency, management efficiency, performance against a benchmark, zero or minimal exit load, etc. For example, you may invest in a fund that has consistently performed better in the past, has a fund manager with a proven track record, has consistently outperformed its benchmark, and there is zero exit load after one year. That being said, past performance shouldn’t be the only deciding criterion as it cannot guarantee equal or better returns in the future.

Diversify optimally
When selecting mutual funds, avoid putting all your money in a single asset category or a single mutual fund product. Try to diversify your portfolio by investing across different mutual fund categories and into different schemes within the same mutual fund category. Optimal diversification can help reduce the investment risk to a great extent.

Active vs. passive investment
In passive mutual fund investments, the fund manager follows the underlying index, and the fund’s return is usually in line with the returns offered by the underlying index. In an active mutual fund investment, the fund manager is directly involved in deciding the structure of the investment portfolio and the scrips that it consists of. The fund management cost and expense ratio are higher in an active mutual fund than a passive fund. So, if you are not looking for an aggressive return and merely intend to mimic the performance of an index such as Nifty or Sensex, you may choose a passive fund. But if you are looking to outperform the index and ready to take a little more risk, you may go for active investments.

The writer is CEO, BankBazaar.com