How to choose a right mutual fund scheme, How to Choose Best Mutual Fund Plans, The right choice of mutual Funds, Making the Right Choice : Mutual Funds. It’s often not possible for an investor to analyse a fund’s performance by applying theoretical jargons because of real life constraints, particularly shortage of time. Some basic homework, nevertheless, always helps to choose the right among many.
How to choose a right mutual fund scheme
Step 1 (object oriented approach): If the investor is very clear about his/her goals and the end use of the appreciation, then macro-level selection of funds becomes easier. Unwarranted risk factors can be eliminated and the investor can choose a long or short tenure in a selective mode
Step 2 (basic economic assessment of the country): One must have a basic idea about the likely economic scenario in the next few years in terms of interest rates, inflation, industrial growth, education and above all GDP growth. This exercise helps the investor to choose the investment span better.
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Step 3 (fund performance study): The investor is required to study the performance of the funds for at least the past five years, collecting data from at least two sources. Fund performance analysis from multiple sources eliminates ambiguity in fund ranking. Schemes having star rating this year may turn out to be the worst performers next year. Here, past performance should be evaluated scientifically to take the correct decision
Step 4 (AUM study): Any mutual fund scheme showing increasing AUM over the years always seems to be a reasonable choice because the statistics confirms the investor confidence level.
Step 5 (expense ratio): The funds factsheet released periodically by all fund houses, reveal the expense ratio. It is the cost that an AMC bears to manage the fund. A scheme with lower expense ratio promises better returns in the future. Funds with a higher ratio should be avoided. Oversized schemes are less costly in terms of the expense ratio because they operate with a large quantum of money.
Step 6: (Study of alpha): The excess return generated by a fund over the benchmark is a valuable study for choosing the right fund for investment. A higher alpha ( ) usually highlights the fund manager’s skill, ability and performance. This adds up to the investor confidence level.
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However, investment decisions are usually influenced by recent facts, information and news, market valuations and sentiments, psychological bias, preferences and above all the advisory. In majority of the cases, the decision is taken on the principle of behavioural finance, instead of scientific analysis. That is why well performing funds are left out in a sluggish market and the promising funds, though not actually so, are bought in boom market. In the first case, the investor loses the opportunity of a good investment and in the later case, the investor loses money when the market falls.
The mutual fund sector in India
A 2013 SEBI study has revealed that 85% of the total AUM of the AMCs, is contributed by Mumbai, Delhi, Chennai, Kolkata and Bengaluru. It also reveals the huge untapped mutual fund market in the country. The gross AUM is just 6.99 percent of India’s GDP, and nothing in comparison to developed nations like the US (83 percent), the EU (42 percent), or the UK (40 percent). Inadequate AMC distribution network, high operational costs in the suburban and rural areas, and lack of investor awareness, are some of the major reasons behind low mutual fund penetration. Setup and operating costs in tier-II cities are higher than that of the top 15 cities in terms of cost-benefit analysis to make the business economically viable
Lack of financial literacy and awareness, is also a major It’s not entirely a problem of the mutual fund sector but of larger financial inclusion. Before the introduction of Pradhan Mantri Jan-Dhan Yojana (PMJDY), only 30 percent of the population had bank accounts. Out of the 6,00,000 rural habitations, only five percent have a commercial bank. Life insurance coverage is spread over only 10 percent of the population and non-life insurance is at a negligible 0.6 percent. The mutual funds sector is no exception. Besides the financial non-inclusion, cultural bias of investors to create physical assets, is another root cause behind the unpopularity of mutual funds in the suburban and rural belts. Retail investors like school teachers, service people, and the common are more comfortable with risk-free bank deposits, post office MIS, RBI bonds, and traditional life insurance products, than mutual funds schemes, except for tax saving purpose like ELSS. They always prefer to buy gold ornaments than mutual funds.
SEBI has adopted several measures to increase participation of small investors. These include allowing cash transactions in mutual funds up to ₹20,000, launching direct plans for reducing the expense ratio, directing AMCs to follow a single expense structure across the plans, encouraging AMCs to set up investor education initiatives, and other schemes. All these target the untapped mass retail investor community. Unless financial awareness is spread to the rural and semi-urban areas, not only will the mutual fund sector continue to suffer, unscrupulous chit funds will carry on exploiting common investors. A joint exercise by the government, SEBI, RBI, AMFI, the Insurance Regulatory and Development Authority, various chambers of commerce and industry, and professional educational bodies, could go a long way to usher in financial literacy.