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Home > Money > Investments Last Updated: Apr 22nd 2021

Criteria to choose Good Mutual Funds

While choosing a mutual fund for investing your money, it is necessary to determine your investment objective. Good return is not just the only criteria for best mutual fund selection. Know more on how to invest, things to check, return consistency, fund manager, expenses.

Criteria to choose good mutual funds

For most people the best mutual fund is the one which generates good returns, but investing with only returns in mind can be counterproductive and you can lose money.

There is no such concept as the best mutual funds and it does not exist, for the simple reason that a mutual fund performing well today may not continue to perform the same in the future. Many retail investors witnessed big losses chasing the illusion of the best mutual funds. The right investment approach is to look for the right fund as per your investment requirement.

1. How to Invest?

A person should try to find the mutual fund that will help him meet his investment goals. It depends on for how long a person wants to invest and also how much risk he is willing to take. Answering these questions will help him to understand which mutual fund category is the right fit as per his investment objective, and he can decide accordingly. If your investment horizon is only one to three years, then you should invest in debt funds. You should never invest in small or mid-cap funds for such a short time horizon, the horizon should be of at least seven years. Meanwhile, if your investment horizon is about three to five years, then you should invest in hybrid funds. You should invest in equity mutual funds only when your investment horizon is more than five years.

2. Things to Check

While selecting a mutual fund the first thing that you need to check is the fund's downside protection. Let's suppose that returns for a particular fund are 20% in the first year, but, in the second year, its returns are -35%. So, this fund is not suitable for investment as it does not have the downside protection.

3. Return Consistency

Always check if the fund's returns are consistent or not. Generally, the broker or broker portal gives us a yearly / quarterly record of past performance. For example, the return for a particular fund in the first year is 8%. In the second year, it's 9%, and in the third year, the returns are 10%. Meanwhile, for another fund, the first-year returns are 11%, second year's return was 2%, and for the third year, it provided a return of 6%. Among the two funds, the first fund is better than the second, as its return consistency is better.

4. Expenses & Fees

Mutual Fund companies charge expenses & fees to manage the fund over a period of time. The fund expense ratio, also known as "Total Expense Ratio" (TER)) is a simple percentage indicator to cover fund expenses that includes sales, promotion, fund manager (the person or team) commission, administrative, communication, audit expenses. Expense ratio varies from fund to fund and may be between 2% to 6%.

The higher the ratio, the lower the investor's return, hence, one need to pay attention while choosing the best mutual fund.

Per SEBI guidelines, the TER is calculated as a percentage of the Fund's average Net Asset Value (NAV). The daily NAV of a mutual fund is disclosed after deducting the expenses. While there are no general limits in what goes into this bucket, effective Apr 1st 2020, TER cannot exceed 2.25% for Equity MF, 2% for Debt MF.

5. Fund Manager

A fund manager plays a vital role for mutual fund investments. Sometimes, a fund is managed by a team. A good fund manager has the ability to turn the worst-performing mutual fund to the best performing fund. He/she is the point person to decide on which stocks or securities to invest and how to distribute the money for a particular mutual fund. If the fund manager is good, then that particular fund will do well. However, if the fund manager is not that efficient, then the fund might not perform well in the future.

Research on the fund manager and his history of investments and the performance. Though the past performance is not a future indicator for a higher return but it is important to know what you are walking into. recommends you to have a blended portfolio, for many stock market and related investments may not be a perfect choice. Check more @ Money > Investments Portal

6. Income Tax on Proceeds

Income Tax is assessed based on how long the investor hold the mutual fund. Gains are classified into Long Term Capital Gains (LTCG) and Short Term Capital Gains (STCG). Gains are considered as LTCG if holding period is more than 36 months otherwise is considered as STCG.

Starting from FY 2018-19, capital gains up to Rs. 1,00,000 in a single financial year will be exempt from income tax and the rest is taxed @ Long term or Short term rates.

Tax rates of STCG covered under section 111A is charged to tax @ 15% (plus surcharge and cess as applicable) and 10% in all other cases. In case of LTCG, it is 10% plus cess.

More information on Capital Gains on mutual funds can be found @ Capital Gains Income Tax Guide

Disclaimer: This article provides an overview and general guidance, not exhaustive for brevity. Please refer Income Tax Act, GST Act, Companies Act and other tax compliance acts, Rules, and Notifications for details.