Mutual fund investment: From expense to risk — These are the factors you must consider before choosing a fund

Mutual fund investments are considered among the best ways for an ordinary retail investor to book capital gains. However, there are varying levels of risk attached based on the type of scheme and that's why you have to choose carefully before making an investment.

A popular tool to achieve financial goals and grow your wealth, MFs have a long-term horizon of five to 15 years with reasonable financial security. Participants or account holders are given units corresponding to their investment sum, for which purchase and sale are at the latest net asset value (NAV).

You can choose to invest with small sums via a systematic investment plan (SIP) or one-time lump sum, as per preference.

How should investors pick a mutual fund?

There is no ‘one-size-fits-all’ option when it comes to mutual funds. You will first have to prepare a document listing out your financial goals and then map out how much of your portfolio you want to allocate for fund houses. Once this is decided, you will need to research for mutual funds that match your goals.

Here's a basic outline of how to structure your research:

• To make a fair assessment, compare mutual funds within the same category, i.e. gold fund, sectoral fund, etc.
• Once you have your category decided, compared expense ratios between offerings to see what fits best for you.

• Expense ratio is the annual fee charged by a fund house. Does Fund A charge significantly more for managing the same assets as Fund B? Over the years, even 1-2% difference can compound into significant loss or gain.
• Next check for consistency of performance by a fund over a medium to long-term. You can track if a fund has consistently beaten its benchmark over three, five and seven-year horizons to make an assessment.
• Third, check for the associated risks. Calculate the risk metrics — how much volatility did the fund manager take on to generate projected returns, how is the sector performance, whether you can risk losing what you invest, etc.

• Note that the best fund does not always provide the highest returns. You will need to carefully allocate for performance vs risk appetite when making your choice. The main guiding factor should thus be your own financial goals and ability to stay invested through the market volatility.

Mutual fund investment: SIP vs lumpsum

SIP: An SIP allows investors to deduct a fixed sum into your preferred MF scheme each month directly from your bank account and spread out your investment over time. The monthly interval also helps build financial discipline for the long run. Spreading out of your investment over months, more often than not averages your cost of purchase toward the lower side, despite market volatility. This means that you end up paying less on average per unit, when compared to lumpsum investment.

Lump sum: In lumpsum investment, you put in a full large amount into your preferred MF at the cost at the time of investment. Here, you lose out on what's termed as rupee averaging, which gives you benefit of reduction in price for the same units during market downturns. It works best for experienced investors with confidence of timing markets for highest returns, and investors comfortable with higher risk for potentially higher returns.

How can I start an SIP? Step-by-step guide

• Choose an asset management company (AMC) i.e. ICICI Prudential, HDFC, Nippon, Kotak and more or an aggregator i.e. Zerodha, Groww, etc. to invest in a mutual fund.

• Complete the know your customer (KYC) process before starting to invest.
• At the time of investing, you need to opt for SIP or lump sum, depending on your needs.
• For SIP, you will have to a separate form instructing your bank to allow regular debit from your bank account towards the purchase in the selected schemes. This may take the bank 7 to 30 days.
• Choose the frequency (whether you want monthly or fortnightly) and number of SIPs (12 or 6) you want to go for.
• Mutual funds allow you to set up SIP for any period from six months onwards with no upper limit.

Disclaimer: This story is for educational purposes only. The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.