Why you should compare mutual funds before making an investment?
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Mutual Fund | March 02
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Why you should compare mutual funds before making an investment?

Mutual funds are widely chosen as an option for investment by prospective investors. In this kind of investment, funds are chipped in from a significant number of investors. This consolidated fund is then invested in different types of securities. A house of mutual fund furnishes a portion of the mutual fund to the investment holders. The loss and profit are equally allocated among the mutual funds investors. Any mutual fund needs to have an official registration from the Securities and Exchange Board of India, commonly known as SEBI, prior to commencing collection of funds from the common public. Before making an investment in mutual funds, it is essential for the investors to not only compare mutual funds but also to peruse the investment objective of the funds. 

Need for comparing mutual funds before making an investment

In today’s marketplace, there exists a vast array of mutual fund options and schemes, thereby, making it challenging for common people to understand which one to choose. That is the most important reason for comparing mutual funds for investing in the right one. Certified depository participants such as LKP Securities have profound knowledge and an acute understanding of mutual funds investment. If you are considering investing in mutual funds anytime soon, you can surely count on them. 


The contemporary marketplace is such that prospective investors have plenty of attractive investment options to choose from. There is a vast range of schemes that looks equally enticing and profitable. Having said that, the apex regulatory body SEBI has always cautioned both naive as well as experienced investors to invest in mutual funds after meticulous consideration. Notwithstanding the time period of the investment, that is either long term or short term venture, you must ensure that your return on investment is the best of its kind. Moreover, no investor will ever want to endanger his finances while making an investment. However, while comparing mutual funds, the return is not the only factor that determines which one will be a better option. Certain crucial aspects such as the previous performance of the mutual fund, evaluation of risk, the mutual fund house’s reputation and other such factors need to be gauged before any decision. Therefore, for understanding the right kind of mutual fund that will meet all the given criteria, one needs to compare them. 


A popular method of comparing two mutual funds is by collating the mutual funds’ net asset value or NAV. This is generally done by considering the net asset value at the beginning and end of a particular time period. 

How can one compare different mutual funds?

Prior to venturing into an investment scheme, you must have a profound understanding of your investment objectives. Based on that, you have to pick out a mutual fund scheme that will meet your goals. Hence, you must begin evaluating all the details available about the concerned mutual fund. Due to the myriads of mutual fund schemes available in the market, it is important to compare them thoroughly before jumping to conclusions. Given below are some of the methods that can be used effectively for comparing two mutual funds. 

Benchmark

Benchmark provides a standard to assess the effectiveness of a mutual fund. The benchmark displays the returns produced by the mutual funds over the original returns that the fund was likely to produce. According to directives given by SEBI, every fund announces a benchmark and it is considered as a standard to gauge the performance of the fund. If the benchmark rises by 14% but the net asset value of the fund rises by 16% then it is considered that the mutual fund has outdone the set benchmark. Making use of an index helps investors to spot a mutual fund that makes a profitable ROI at the time of market performance. 

Investment horizon 

An investor’s investment horizon is a principal element in the comparison and choice of mutual funds. In layman’s words, an investment horizon is the time period during which any given investor remains invested in a given mutual fund. The prospective investor remains invested in a specific mutual fund in compliance with his respective investment horizon. For instance, if an investor is considering a horizon for long-term investment, he has to go for equity funds. However, he must be ready to take risks involved as equity funds are infamous for unforeseeable returns. On the contrary, if an investor is in for a horizon for a short-term investment, he can go for liquid funds as it is a more worthy investment option. Although the return on liquid funds is comparatively low, they are more secure than other kinds of funds. It is essential that the funds that you are willing to compare match your investment horizon. When you tend to compare equity mutual funds, you have to compare their returns for at least a period of seven years or more. On the contrary, when you decide to go for liquid mutual funds, you must compare them for a period of at least a year. 

Expense ratio

The expense ratio of a mutual fund scheme refers to the annual expenses spent on operating the respective fund. This includes factors such as advertising, management, administration expenses of a specific scheme. In layman’s words, if two per cent is the expenditure ratio of a given mutual fund per annum, it means that two per cent of the overall assets of the mutual fund will be utilized to cover the respective expenditures in that given year. According to the current directives given by SEBI, the expense ratio is interchangeable and the apex body has not levied any upper ceiling on any specific kind of expenditure allowed, provided that the overall expenditure does not exceed the limits recommended by the apex regulatory body. 


If the expense ratio of a particular fund is high, the returns on investment will be low. Thus it is wiser to choose funds that have a low expenditure ratio. 


While venturing into mutual funds, it is wiser to compare mutual funds that fall under the same segment. Avoid comparing two different plans, for instance, comparing a regular scheme with that of a direct scheme or comparing an actively managed fund with an index fund scheme. As each of these categories is different, their expense ratio will be completely different as well. Hence it will be of no use to compare two different types of mutual funds. 


Also, Read: Which stock market mutual funds are best to invest in?


Type of industries and underlying securities

The mutual funds usually function by investing the pooled amount into different kinds of securities. The investment must be in line with the objective of the mutual fund. Moreover, every fund must comply with the guidelines set by SEBI in this respect. For instance, in the case of an equity mutual fund, a total of 65% has to be invested. The risk profile of the respective fund might be impacted by investing in the underlying assets. However, it is not mandatory for two different kinds of funds to have a similar sector allocation. 

Risk factor

All the offer contracts of mutual funds states that they are prone to risks of the marketplace. Thus, choosing any kind of mutual fund will involve a certain degree of risk. Based on the type of fund and scheme you select, you will have to encounter either high or low risks. However, it is important to note here that choosing high-risk investment options does not mean that you will likely receive higher returns. The risk factor of any given scheme is evaluated by alpha and beta- the two financial ratios for risk assessment. Alpha indicates the amount that the fund manager is likely to deduct or add from the returns on the portfolio, whereas beta informs the investor about the degree of risk that the investment entails.  


Although these factors are extremely helpful in comparing mutual funds, doing it all by yourself may become intricate and quite onerous. Therefore, you can take assistance from LKP Securities which is a renowned and experienced advisor in the field of mutual funds.


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