So you’ve decided that you’re going to invest some money in mutual funds. But you are uncertain as how to determine which mutual fund is the right one for you. There are a few key things to consider in making the decision as to what kind of fund to put your money in. Let’s take a look.
Establish your goals – As with all activities, it is critical to define what your goals are at the beginning. Clearly articulating the end results expected for the money you are investing will make all the other decisions that follow easier. Are you trying to park and grow a bit of your revenue towards starting a business? Are you saving for your children’s education years down the line? Be clear about what you hope to accomplish.
Duration of investment – The time period in which you expect to receive your return; or conversely, the time period for which you can afford to have your capital tied up is very important to consider. For instance, Money Market funds (which invest in Treasury Bills, Commercial Papers etc.) are a good instrument for short term investments. They are easy to enter and exit. In addition to this, the mix of investments allow you to keep your capital safe, while earning a decent upside. Equity funds (which invest in quoted equities) require a longer term investment view as they can fluctuate quite a bit in the short term but are generally quite profitable over a longer investment period.
Level of risk tolerance – How aggressive are you willing to be with your investment? Mutual funds that carry higher risks will likely pay a higher return, but they may not be for the investor who is simply seeking low risk growth of their extra income. It is essential to know what sort of investor you are. Your investment should provide a good return without causing you heart palpitations of fear for your money. A risk averse investor might choose a bond fund, which invests in government and corporate bonds. Such a fund would be quite low risk as the risk of default by governments and large corporations is quite low. It would offer a fairly steady and unremarkable rate of return because of this stability. An equity fund on the other hand can offer much more exciting returns but there would also be significantly more volatility, making it unsuitable for investors who are really cautious about their money.
Charges and Fees – Mutual funds make money through “sales charges”, which must be considered in thinking about the returns of your mutual fund. Sales charges are the commissions charged by the Fund Manager for selecting and managing the right mix of investments in a mutual fund. Some funds charge a portion of what you invest in what is called a front-end load fee. Others charge a back-end load fee, which is taken out of your investment when you sell at the end of your investment period. Alternatively, some mutual funds will charge an overall administrative fee. It is key to look carefully at these charges and consider how they will affect the overall returns from your fund.
Reputation and previous performance of the fund – You will want to invest in mutual funds sold by a reputable fund manager. Looking at the previous performance of the various funds under management can give you a sense of whether this is a well-managed entity and if the returns to be provided match your needs. Examining previous performance will allow you to determine if a fund has too much volatility (swings in performance) for you comfort and how consistent its performance has been over time.
Picking a mutual fund may seem a big task but clearly defining your objectives, deciding how long you are willing to tie your money up for and how much risk you are willing to assume will set you on the right path. The rest is about finding a firm with a history of performance and finding the fund whose fee structures match your objective. Happy investing.
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Source: The Guardian