As soon as our first salary hits the bank, it feels like the world is ours to conquer. We start dreaming big—buying a car, traveling the globe, maybe even retiring early. But let’s be honest: can these be achieved with just paychecks if we don’t plan and invest smartly?
Not only have I been in that position myself, but I’ve also seen many young clients struggle with the same questions: where do I start, and how do I make my money work for me? One popular and effective way is through mutual funds. But with so many options out there, how do you pick the right one?
Let me walk you through the essentials, step by step, to confidently select a mutual fund that fits your goals, risk tolerance, and financial horizon. Let’s dive in!
Step 1: Figure Out Your Goals and Risk Tolerance
Before diving into mutual funds, you need to be clear on your goals and how much risk you’re comfortable with. Ask yourself:
- What am I investing for? (e.g., traveling the world, buying a home, paying off education loans, retirement, etc.)
- How long do I have to reach my goal? (short-term vs. long-term)
- How much risk can I handle without losing my sleep?
If you’re in your 20s or early 30s, time is on your side, and you can take on higher risks with growth-focused funds. But if your goals are short-term—say, within 3–5 years—it’s better to focus on stability with fixed-income funds.
For Example:
- If you want to build wealth for your retirement (long term) but also want to buy a house in the next 5 years (short term), you can invest a larger portion of your money in growth equity funds for long-term gains and use debt or balanced funds for your short-term goal of buying a home. By smartly dividing your investments like this, you set yourself up for success.
Step 2: Understand the Different Types of Mutual Funds
Once you figure out your goals and risk-taking capacity, it’s time to understand different types of mutual fund options. Knowing the pros and cons of different kinds of mutual fund options enables you to pick the right fit for your needs.
Here’s a quick cheatsheet for you:
Equity Funds
Equity funds invest in stocks, aiming for long-term capital appreciation. They are suitable for investors with a high-risk tolerance and a long-term investment horizon. The different varieties of equity funds include:
Large-Cap Funds:
Stable and less volatile.
Mid-Cap Funds:
A balance of growth and stability.
Small-Cap Funds:
High growth potential but riskier.
Sectoral Funds:
Focus on specific industries like tech or finance.
Thematic Funds:
Align with big ideas like sustainability or healthcare.
Debt Funds
Debt funds are invested in fixed-income securities, with the aim of earning regular income. They are suitable for investors with a low-risk tolerance and a short-term investment horizon. The different categories of debt funds include:
Liquid Funds:
For short-term parking of money.
Short-Term Funds:
Low risk, moderate returns.
Gilt Funds:
Government-backed, low-risk.
Credit Risk Funds:
Higher returns but riskier.
Hybrid Funds
Hybrid funds combine equity and debt investments, aiming for balanced returns. They are suitable for investors who want to diversify their portfolios and reduce risk. The different types of hybrid funds are as follows:
Balanced Funds:
Moderate risk and returns.
Dynamic Funds:
Flexible investment approach with moderate risk.
Arbitrage Funds:
Low risk and moderate returns.
Multi-Asset Funds:
Diversification benefits with moderate risk.
Other Types of Funds
Index Funds:
Track a specific market index, such as the Nifty or Sensex. They provide broad diversification and low costs.
Exchange-Traded Funds (ETFs):
Trade on stock exchanges, providing flexibility and diversification. They offer low costs and tax efficiency.
Fund of Funds (FoFs):
Invest in other mutual funds, providing diversified exposure. They offer convenience and moderate risk.
Real Estate Funds:
Invest in real estate assets, providing exposure to the real estate market. They offer diversification benefits and moderate risk.
Commodity Funds:
Invest in commodities, such as gold or oil. They provide diversification benefits and moderate risk.
Insightful Experience
A client visited our office, excited about her upcoming wedding, just a year away. Determined to boost her savings, she had decided to increase her SIP in Large-Cap Mutual Funds. She was drawn by the higher return potential of the large-cap equity mutual funds.
When we discussed her plan, I showed her the other side of the coin. I explained how equity funds, while great for long-term growth, could be risky for short-term goals due to market fluctuations. Together, we analyzed her timeline and the current market scenario.
Realizing the importance of stability, Priya made a thoughtful shift to a Debt Mutual Fund for the year. This smart move aligned her investments with her wedding plans, ensuring peace of mind and financial security.
I feel happy that I could educate my client in the right direction and made her pick the mutual fund that complemented her requirements.
Step 3: Do Your Research: Past Performance & Fund Manager
Now that you know your goals, risk capacity, and the types of mutual funds available, it’s time to dig deeper. Here’s what to look for:
Evaluate Past Performance
While history doesn’t guarantee the future, it offers clues. Compare a fund’s performance over the past 3–5 years against its benchmark index.
Check the Fund Manager
For actively managed funds, checking the fund manager’s track record is important. The person calling the shots matters. Look into their track record and investment style. A strong, experienced manager can make a significant difference in returns.
Step 4: Understand Basic Metrics to analyze Mutual Funds
After all these steps you need to understand the basic metrics based on which you can gauge the mutual fund’s performance. Don’t let the terms or calculations scare you. Let me give you a quick run-through.
Mutual fund Returns
Absolute Return:
The total return of the fund over a specific period.
Relative Return:
The return of the fund compared to its benchmark or category average.
Annualized Return:
The return of the fund over a specific period, annualized to facilitate comparison.
Mutual fund Risk
Standard Deviation: Measures the volatility of the fund’s returns.
- Beta: Measures the fund’s sensitivity to market movements (1 = market return, >1 = more volatile, <1 = less volatile).
- Sharpe Ratio: Measures the fund’s excess return over the risk-free rate, relative to its volatility.
Mutual fund Performance Ratios
- Alpha: Measures the fund’s excess return over its benchmark, adjusted for risk.
- Information Ratio: Measures the fund’s excess return over its benchmark, relative to its tracking error.
- Sortino Ratio: Measures the fund’s excess return over the risk-free rate, relative to its downside volatility.
Mutual fund Fees and Expenses
- Expense Ratio: The percentage of the fund’s assets deducted to cover operational expenses.
- Load: A fee charged by the fund when you buy or sell units.
- Total Expense Ratio (TER): The total fees and expenses charged by the fund.
Mutual fund Portfolio Characteristics
- Asset Allocation: The distribution of the fund’s assets across different asset classes.
- Sector Allocation: The distribution of the fund’s assets across different sectors.
- Top Holdings: The fund’s largest holdings, which can give you an idea of its investment strategy.
Other Metrics
- Turnover Ratio: Measures the fund’s trading activity, which can impact returns and fees.
- Dividend Yield: The ratio of the fund’s dividend distribution to its net asset value.
- Net Asset Value (NAV): The fund’s per-unit market value.
Step 5: Use the Magic of Diversification and Risk Management in Mutual fund investments
Last but not least, you have to learn to manage your risk by diversifying your mutual fund investments. This is a non-negotiable when investing in mutual funds to minimize losses and maximize returns. By spreading your money across different asset classes, sectors, or regions, you reduce the impact of a single bad investment.
Example:
Let’s say you invest ₹10 lakhs:
| Fund | Investment Amount | Return (1 year) |
| Fund A (Equity) | ₹5 lakhs | -15% |
| Fund B (Debt) | ₹5 lakhs | 8% |
If you had invested the entire ₹10 lakhs in Fund A (Equity), you would have lost ₹1.5 lakhs (-15%). However, by diversifying your investment across Fund A (Equity) and Fund B (Debt), your overall return would be:
(₹5 lakhs x -15%) + (₹5 lakhs x 8%) = – ₹0.75 lakhs
By diversifying your investment, you reduced your losses from ₹1.5 lakhs to ₹0.75 lakhs.
My Take
Choosing the right mutual fund is simpler than it seems. By understanding your goals, risk tolerance, and investment horizon, you can make smart choices for long-term growth. Diversifying, researching fund managers, and knowing key metrics will help you stay on track.
The journey to financial freedom starts with one step—investing wisely. If you’re ready to take control of your financial future, remember, the MoneyAnna team is here to guide you every step of the way. Let’s make your money work for you!
