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6 Dumb Ways to select a Mutual Fund scheme

6 Dumb Ways to select a Mutual Fund scheme

“Mutual Fund INVESTMENTS are Subject to Market RISKS, Read all scheme related documents carefully before investing.” Many times we get to hear or read this one small line wherever we come across mutual fund investments. This disclaimer is for everyone who is either new to investing or already an investor. But do people really follow this disclaimer?

Many times investors take dumb decisions of investing in a particular mutual fund scheme thinking they will get high returns. But in reality they might be just burning cash for no use because the investment may not suit their risk profile, financial requirements or simply not give them the desired outcome. Mutual Fund investments are highly sensitive and full care should be given while selecting a particular scheme. One should not just follow advices blindly and make investment decisions. Remember, informed decisions are better than following blind advice.

Dumb Ways to select a Mutual Fund scheme

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Dumb ways investors use to select mutual fund schemes:-

Before starting let me clarify – fund selection is one of the least important criteria in investing but we need to avoid big mistakes.

Star Rating from Research companies (second worst way)

There are various research companies in our country which publish their ratings online on particular schemes. Also few magazines and newspapers publish their own ratings every fortnight or every month. These Ratings are based on the historical returns and volatility and other factors. The fund with highest returns in recent past or less volatility gets higher rating. Now this cannot be a good reason to select scheme they are only considering 3 years – which is not even equal to one phase of market.

Morningstar candidly admits that its star rating have little or no predictive power – but still most of the new money flows to the funds which recently got higher rating. I got a chance to have discussion with Dhirendra Kumar of Valueresearch – I bluntly asked him about purpose of star ratings & he said “you can use 1 Star & 2 Star (lowest ratings) to avoid these funds”. So he is talking about avoiding only 37.5% of the funds – that means your universe is rest 62.5%….. “62.5%”

Investing in Best performing funds

Worst way of selecting mutual fund is looking at the best performer of 1-3-5 years. These funds came to limelight with a very short performance – you will surprised to know that even 1 Qtr phenomenal performance (which can be plane luck) can bring any fund from 4th quartile to 1st quartile. We have time & again explained there are no best funds – at least if we just look at the performance numbers. Stop chasing the top performers to avoid disappointment in future.

Lowest NAV

Often people prefer that scheme which has lower NAV. The reason behind doing this is just because they will get more units with the amount invested. As per them schemes with higher NAV are expensive and have less potential to grow in comparison to other schemes. However, they don’t understand that it’s a myth and Low and high NAV can’t be deciding factor to select a scheme. It’s all about percentage returns – weather NAV is 10 or 100. In case if NAV is high – it’s a signal that this fund has seen lot of market phases. Even few agents try to use this misconception to mis-sell Mutual Fund New Fund Offers (NFO) – 10 ka lelo 🙁

Sector Specific Schemes

One can always find research analysts on business channel, trying predicting next best sector to perform. Majority of people, who do not invest directly into equities, make this as a base to select sector specific Mutual Fund scheme. Infrastructure fund, Manufacturing fund, MNC fund, banking fund, etc. are such names which attract investors who follow such “Financial Pundits.” While some of these funds have generated good returns in past, at the same time majority of these have failed to perform. So, one should not consider such schemes for investment, rather can look at diversified equity funds which diversify the investment by investing in different sectors. If you still want to invest in sector funds – limit yourself to 5% of total equity allocation.

Tracking big investor’s, friends & family’s Portfolio

Consulting an investment advisor is still found very rare in India. One of the major reason is that every alternate relative or friend keeps giving advice on which scheme to select. They don’t understand that each and every individual has different reasons to invest; also the risk profile is different. For one friend the investment can be for 15 years while for another it can be for just 5 years.(Even if it’s same, personal situations can be diagonally opposite). If you are thinking to copy portfolio of a big investor, may be investments is his sole income unlike your situation. And choosing the same scheme for both can be dangerous for financial health.

Investment over Names instead of Processes

We Indians make heroes out of real people and worship celebrities. In investments also lot of people follow a particular person – like a flamboyant fund manager, a celebrity CEO or a big sponsor company behind the mutual fund trust. Investments are about discipline, processes and hard work and opposite of noise culture. Track for integrity and companies who make less noise and dedicated to what they are hired to do. Best way is to focus on processes a mutual fund company follows rather than chasing people who play musical chair in every bull-run. Even if you like some fund manager & followed him for more than a decade – still don’t invest more than 15% in his schemes. I have seen investors putting more than 50% of their money (in one case 80%) in funds of their favorite fund managers or CIOs.

The key is to think well and analyse before investing. Moreover, it is all about hard earned money. Just like fishing in an empty pond will not help you catch fishes, making non useful investments will not get you desired results. So, before selecting any scheme, one should properly analyse his goals, risk profile and then only should invest. Also one can consult an experienced advisor who can guide them at least better than their friends and relatives.

So do you follow above points or invest wisely?

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  • Santanu April 13, 2015, 1:16 pm

    This is a very useful article for a beginner who is going to invest in MF. Actually people don’t have much knowledge about MFs and mostly they choose a fund is by following the history only.

  • Rabindra April 14, 2015, 11:03 am

    Thank you.
    So what is a smart way of selecting mutual fund?

  • rajanikant v gajjar April 14, 2015, 11:34 am

    do write about NON DUMB ways one should follow as well

  • Sagar April 14, 2015, 3:38 pm

    Nice…. The next article should be ” 6 smart ways to select mutual funds” 🙂

  • David April 14, 2015, 5:39 pm

    OK this tells how not to select an MF, plz let us know what is the best or proven way to select any MF.
    As posted here, i did buy a MF by checking its past performance…i dont know the correct way of choosing a MF. Plz help me understand. Thanks.

  • Vikas Agarwal April 14, 2015, 6:47 pm

    Great most of you asked the same question “what are smart ways to select mutual funds”. That’s the reason I selected this to be our first article – I was expecting these replies.
    If you notice in beginning of the article we mentioned “Before starting let me clarify – fund selection is one of the least important criteria in investing but we need to avoid big mistakes.” You should check this
    Actually selection of Mutual Fund is “losers game” – you can’t win it by better skills, you can win it by avoiding big mistakes.
    We will be talking about constructing portfolio in some future post.

    • jitendra May 5, 2015, 11:53 pm

      Nice article…Vikas. Specially that one 10 ka lelo 🙂

  • Shailesh unawane April 15, 2015, 12:02 pm

    Awaiting next article ‘the 6 smart way to select MF.

  • Anil Kumar Kapila April 17, 2015, 6:31 pm

    Very useful article.I would advise investors to read this article before seeking advice regarding various funds.

  • Anil Kumar Kapila April 17, 2015, 6:49 pm

    Hi Hemant
    Everybody wants spoon feeding.It seems people don’t have time to even read articles appearing in your blog.I like to take printouts of articles appearing in TFL and read them again and again.

  • parry April 19, 2015, 6:44 pm

    1. so how do we select MF ?
    2. please tell us atleast 2-3 good MFs in each category. LC,MC, SC and thematic with time horizon of 4-5 years.

    • Anil Kumar Kapila May 19, 2015, 4:22 pm

      It is not possible to suggest good mutual funds for 4-5 years. Funds which may appear to be performing well today may not perform well continuously for five years. The key is to keep tracking the performance of funds after selection.

  • Radhika June 26, 2015, 11:16 pm

    Good blog post. I absolutely love this site. Continue the good work!

  • Amit C June 29, 2015, 10:35 pm

    Simply want to say your article is as astounding. The clearness in your post is simply nice and i could assume you’re an expert on this subject.

  • Sapna Haryanavi January 5, 2016, 10:45 am

    This is a great Post and I’m glad that you shared these ideas.