Mutual funds are a great investment avenue to create wealth and diversify your investment portfolio. They are suitable for any age group but yield the maximum returns if you start investing at a young age. But investing in mutual funds can be profitable only if you know the crucial steps to navigate it beforehand. Knowing what factors affect the returns earned in mutual funds will give you a clear idea of which mutual funds to pick. Here are four tips to guide you towards suitable mutual funds.
Know your investment goals and horizon
Before you start investing in mutual funds, it is crucial to identify your future goals and the time frame for their fulfillment. The time you have in mind influences your investment horizon and the suitable mutual fund type. For instance, if you have a short-term goal like paying EMIs, house rent, a trip, debt funds would be ideal. If you have a long-term goal like retirement, buying a house, or paying for your child’s college education, then equity funds, especially a SIP (Systematic Investment Plan), would be right.
Identify your need for liquidity.
Once you have some clarity on your goals, it becomes easier to recognize the mutual funds needed to fulfill them. As mentioned above, short-term goals require debt funds. Debt funds are more liquid, meaning you can encash the returns earned through them in 1 to 3 years. If your plans are long-term and you don’t need to encash the fund returns immediately, equity funds will be your best bet. Equity funds help you amass a larger corpus than debt funds as they are kept for a longer duration, say at least 7 to 10 years and grow through compounding.
Understand your risk tolerance
The liquidity you prefer will also dictate your risk tolerance. Each fund carries some risk with it. Debt funds are low-risk, and equity funds are high-risk. However, the volatility gets balanced when you stay invested for a long tenure in equity funds. There are various types of equity and debt funds, and the risk attached to each fund is mentioned. These funds include multi-cap funds, small-cap funds, mid-cap funds, liquid funds, credit risk funds, and so on.
Pick a fund house/manager with expertise.
Generally, fund houses manage mutual funds. Fund houses or asset management companies invest your money on your behalf and control the financial instruments you pick. Their role involves deciding when, where, and how to invest the money and which funds to choose. They monitor the stock market cycle and then take decisions regarding your funds. Make sure the fund house you pick knows your investment goals. Ensure that you have checked their past performance and expertise level, the expense ratio, exit load, and other fees they charge.