5 Questions to Ask Before Investing in Mutual Funds

Do you want to grow your wealth? Are you looking to invest in mutual funds to achieve your financial goals? You may consider asking these questions before putting your money into mutual funds. You could invest in mutual funds after setting your financial goals. You may also decide on the time horizon of your investment in mutual funds. Put your money in mutual funds only after considering your risk appetite.

Let’s take a look at the five questions to ask before investing in mutual funds. 

• What is the past performance of the fund?

You could examine the track record of the mutual fund before investing your money. You may consider looking at the average annual return of the mutual fund over the last five to ten years. You get an idea of the performance of the fund over different market conditions. 

You must select a mutual fund that has consistently beaten the benchmark in a rising and falling market. You may check the investment objectives of the fund. It must match your financial goals. 

Select a mutual fund only if you are comfortable with the investment style of the fund manager. It signifies the method of investing your money in the mutual fund portfolio. You may take a look at the past performance of the mutual fund from the website of the asset management company. 

• Does the mutual fund have a low expense ratio?

The expense ratio covers all the costs incurred in the management of the mutual fund. The mutual fund deducts the expenses of managing the fund from your investment. Equity funds may charge a maximum expense ratio of 2.25% and debt funds up to 2%, depending on the assets under management of the fund. 

The expense ratio eats up the return from your mutual fund investment. Moreover, you would also incur the expense ratio regularly. You may consider checking the expense ratio, which is a crucial differentiator among similar mutual funds. 

Also Read: Should You Invest in International Mutual Funds?

Direct plans of mutual funds have a low expense ratio as compared to regular plans. You invest your money directly with the asset management company. It helps you to save on the expense ratio as the AMC won’t pay commission to the mutual fund distributor. You would get a higher return on the mutual fund investment over the long-term. 

• What is the composition of the mutual fund?

You could pick a mutual fund that puts your money entirely in equity and equity-related instruments. A debt fund invests your money in bonds and other fixed-income securities. However, you may also consider putting your money in a balanced fund. It invests in a mix of both fixed income and equity instruments.

You must take a look at the composition of the mutual fund and invest depending on your risk tolerance. For example, you may not feel comfortable putting your money in an equity fund, if you are a conservative investor. Investing in a balanced fund may protect your investment from volatility during a stock market correction. 

• Do mutual funds offer tax benefits?

You may consider investing in the equity-linked savings scheme or the ELSS. It is a tax-saving mutual fund that puts the bulk of the corpus in equity and equity-related instruments. Equity-linked savings scheme has a compulsory lock-in period of three years. 

ELSS mutual funds qualify for a tax deduction up to a maximum of Rs 1.5 lakh in a financial year, under Section 80C of the Income Tax Act, 1961. You may invest in ELSS and save up to Rs 46,800 a year in taxes if you fall in the higher income tax brackets. 

• How long can you invest in the mutual fund?

You could select the mutual fund depending on your investment horizon and financial goals. For example, you may have to invest your money in a debt fund for a short-term financial goal. 

However, you may consider investing in an equity mutual fund for long-term financial goals, such as retirement planning or buying a house. Equity investment may generate an inflation-beating return over the long-run. 

You could invest in mutual funds to diversify your portfolio. You may consider investing your money based on your financial goals, investment horizon, and risk appetite. Select a mutual fund that consistently beats the benchmark over some time. You must track the performance of your mutual fund portfolio at least once every six months. In a nutshell, you must ask the right questions before investing your money in a mutual fund. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in