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How to choose the best mutual funds?
Fri, 22 Aug Pre-Open

Mutual funds are supposed to make life easier for you, the equity investor, right?

In theory, that's what they are supposed to do. By taking away the job of actively choosing the right stocks for investment from investors who have neither the time nor the skills to do so.

Thus in the process enabling investors to invest in equities without the headaches involved.

But while they do help you sidestep the pains of stock picking, for the average investor, mutual fund picking ends up becoming a task no less arduous.

The numerous mutual funds houses, multiplied by the sheer number of mutual fund schemes offered by each mutual fund house, and you have a seemingly endless list of permutations and combinations.

So how does one choose the best mutual fund?

While we do not have an expertise in mutual funds, there are indeed a few common sense principles you can follow to help you along the way -

  1. Look at funds only from fund houses that are renowned names and have long track records. This could be a great initial filter to increase the probability that your funds will be managed in the right way.

  2. When looking at past performance, anything below 5 years could be completely meaningless. This is because in shorter time frames, even funds that do not have a sound process of picking stocks in place, could have a market beating performance. But as the flavor of the markets changes, longer term performance could be radically different.

  3. Invest in diversified funds rather than sector and theme based funds. If you do not have the expertise to pick stocks, there's no reason to assume that you will have the expertise to pick the right sectors to stake your money on.

  4. All else being equal, choose funds that have relatively lower expense ratios amongst the lot. The expense ratio is the amount of money the fund will charge you (as a percentage of the value of your funds) to manage your money.

  5. Do not invest all your money in one or two funds. Pick at least 5 funds carefully chosen with the above things in mind and spread your investment over these.
There is a lot more complexity and detail one could go into and keep track of as far as mutual funds are concerned.

However, if you are like the average investor, just like you do not have the time or expertise to do a detailed analysis for picking your own stocks, you will probably also not have the time or expertise to do a threadbare analysis of mutual funds. However the above principles will you hold you in good stead as broader guideposts to use while picking your equity mutual funds.

How do you choose the best mutual funds? Do share your views on the Equitymaster club.

For information on how to pick stocks that have the potential to deliver big returns, download our special report now!

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