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Mutual Funds - Strategies to invest in a mutual fund

03-Apr-2003

What's strategy got to do with selecting a mutual fund? Shouldn't you just go and invest in the best performing fund? The answer is no. Mutual fund investing requires as much strategic input as any other investment option. But the advantage is that the strategy here is a natural extension of your asset allocation plan. The following process is recommended:

Risk tolerance:
Just as you would buy a computer that fits your needs and budget, you should choose a mutual fund that meets your risk tolerance (need) and your risk capacity (budget) levels (i.e. has similar investment objectives as your own). Typical investment objectives of mutual funds include fixed income or equity, general equity or sector-focused, high risk or low risk, blue-chips or turnarounds, long-term or short-term liquidity focus.
Past performance of the fund:
Although past performance is no guarantee for the future, it is a useful way of assessing how well or badly a fund has performed in comparison to its stated objectives and peer group. A good way to do this would be to identify the five best performing funds (within your selected investment objectives) over various periods, say 3 months, 6 months, one year, two years and three years. Shortlist funds that appear in the top 5 in each of these time horizons as they would have thus demonstrated their ability to be not only good but also, consistent performers.
Spread your risk:
Don't just zero in on one mutual fund (to avoid the risk of being overly dependent on any one fund). Pick two, preferably three mutual funds that would match your investment objective in each asset allocation category and spread your investment. We recommend a 60:40 split if you have shortlisted 2 funds and a 50:30:20 split if you have shortlisted 3 funds for investment.
Check out the Sales load:
The cost of investing through a mutual fund is not insignificant and deserves due consideration, especially when it comes to fixed income funds. Management fees, annual expenses of the fund and sales loads can take away a significant portion of your returns. As a general rule, one percent towards management fees and 0.6 percent towards other annual expenses should be acceptable. Carefully examine load - the fee a fund charges for getting in and out of the fund.

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