How do you choose a mutual fund?

Most of the time what is the first thing any common investor does when s/he wants to invest in mutual
funds. Most of us go to famous websites and see the start rating funds. As we do not want to rely on a
single website we go and check 2/3 such websites and finalize the funds which are common on these
websites.

We select 5 such 5/4 star funds even if our monthly investment is, say 5k or 10 k as we want to spread
our risk for diversification and choose 5 funds to invest in. But have you ever checked whether you really
have diversified or just blindly follow the star rating criteria and start investing without any thought
process required for investing?

Now when we select the fund based on such star rating such investors feel they are sorted and now they
just need to check for which goal these mutual funds should be mapped. Sometimes it is found that
most of the investors do not know the nature of the fund in which they are investing, they do not know
its type, its investment philosophy neither its inherent risk. So sometimes for short-term goals, they
match a value fund/contra fund or even a mid/small-cap fund.

After 6 months or a year when they again check the list many of the selected funds are out of the list or
their rating has dropped. Their funds are not in the top 5 and in such a situation their confidence in
investing shaken up a lot. They hurriedly want to come out of the earlier selected funds and start
investing in new star-rated funds and repeat the same mistake again and again.

Such kind of selection of mutual funds is very risky and it lacks sustainability and the ability to invest
consistently for the long term. Kindly keep in mind on most of the website funds are rated just keeping
funds’ one-year performance in mind. They publish a common list for equity and debt mutual funds
mostly containing all sorts of mutual funds categories together. Eq in equity mutual funds large-cap,
multi-cap, mid-caps, value funds, contra funds, thematic/sectorial, flexicap funds and small caps all are
included. So sometimes if the large-cap sector is doing good then you may find 3 large-caps in that list or
when a mid and small-cap section is doing good then you may end up buying the same category fund
and you may not know the mistake if you can not understand the nature of the mutual funds.

Before SEBI categorization mandate fund names were so misleading that knowledgeable investors
sometimes got confused about the fund category. Now because of SEBI’s strict instruction, many things
are clear but still, common investors still find it hard to understand what value, contra, dividend yield or
focussed funds mean.
So kindly understand the selection of mutual funds is not so easy task and you just blindly select the so-
called best funds as per the websites.

The selection of mutual funds depends on many factors such as

# Term to your financial goal,

# Nature of the goal,

# Risk-taking ability of the investor

# Mutual fund and AMC's track record,

# Whether the philosophy of this particular fund matches with the investor and the goal required,

# Mutual fund manager's skills and experience,

# Expense ratio of the fund

# The performance of the fund in bull and bear market both at least for last 7/10 years.

# As well as downside protection it can offer in a bear market

I give importance to the above-mentioned points than star rating as these ratings are very subjective as
well as sometimes misleading. If you all know, the debt funds which were shut down by the Franklin
AMC were 4/5 stars rated, and still, these were abruptly closed down without any notice, and clients'
money was locked.

I always tell my clients that My job is to access the risk and try to minimize it than blindly following the
return.
I follow the Core and Satellite Approach to construct the client’s equity portfolio. According to this
strategy, bifurcation should be -

# 50% investment in an Index fund (least expense ratio and passive investing )

# 30-25% in Flexi/multi-cap, (giving a flavor of active management)

# and remaining in Equity Hybrid fund

for long-term 10+ years goals. (nearest to round off.)

For Debt, I stick with liquid/money market and arbitrage funds only so that we can substantially reduce
credit and default risk along with a better post-tax return than FD.