Have you ever invested in a mutual fund? If your answer is yes then I am sure you must have done a bit of a research before selecting a scheme. Or have you invested on somebody’s tip? If you have invested in a mutual fund scheme on somebody’s tip, then did you get the tip on how to manage that investment? Do you know how long you should hold on to it?
You see, most of us invest in various schemes just like that; on somebody’s tip. And then if something goes wrong, he/she doesn’t know what to do; whether to sell it off or hold on to it. That is why I prefer to do it right from the beginning itself. I would do a bit of research myself before making any investment.
Now let me ask you, if you researched and invested in a mutual fund scheme, how did you do it? Generally people select a mutual fund scheme either by tip or by the ratings given by various entities. But is that the right way to select a mutual fund investment? My answer would be, as you must have guessed, “No”. As the aim of this blog is to guide you to make your investments intelligently, let me show you the 5 Tests For Selecting A Mutual Fund.
- Sharpe Ratio: The very first thing I would like to see in a mutual fund scheme is the Sharpe Ratio. Sharpe Ratio is the excess returns that a scheme has generated over normal returns from guaranteed saving instruments, say Fixed Deposits, divided by a statistical term called Standard Deviation. Sharpe Ratio measures the returns of a scheme for the degree of risk it has undertaken. So among a list of mutual fund schemes which has the same kind of risk, say Equity Funds, higher Sharpe Ratio means it’s return is better than the others.
- Alpha: Every fund has a benchmark, like Nifty 50, Sensex, etc., which it tries to beat. Alpha measures a fund’s excess returns in comparison to it’s benchmark. If a mutual fund scheme has an alpha of 5%, it means that it has outperformed it’s benchmark by 5%. Hence higher the Alpha, better the fund.
- Beta: Beta measures the volatility of the mutual fund scheme compared to it’s benchmark. Beta measures how much the fund will move compared to it’s benchmark. For example, if a fund has a beta of 1.2% and it’s benchmark, say Nifty, rises by 10%,it’s expected that the NAV of the fund will rise by 12%. So, again, higher the Beta, better the fund.
- Expense Ratio: This measures the costs incurred by the fund, say the brokerage that has been paid. It also includes salary, overheads, etc. incurred annually. If the expenses incurred by a mutual fund scheme is high, it will affect it’s returns. So the funds in which the Expense Ratio is low, signifies a well diversified and managed scheme promising a good return in the future. Lower the Expense Ratio, the better.
- Fund Consistency and Reputation: Last but not the least, check to see that the fund has outperformed it’s benchmark over a long period of time consistently, say 5 years. If it has, it shows that the fund has the capability to continue doing the same in future. And if the fund is from a reputed business house, having all the resources and the talent, there’s no reason why it shouldn’t.
So there you go. I am sure that from now on you will research before making any investment in a mutual fund scheme and research intelligently as above. Now if you are wondering as to how long your investment horizon should be, or what to do when your selection has not given the kind of returns you had hoped for, keep an eye on this blog and make sure to come back again where I would answer those queries for you.
Goodbye and God bless.