Here below we are going to discuss with example of how nick choose best method for selection of mutual funds
The other day, I met a cousin of mine -Nick. he is 25, works as an Developer manager in an IT firm, earns well, and lives in Mumbai. At dinner, Nick casually mentioned something about feeling overwhelmed about money. As I asked my cousin gentle probing questions, I realised my uncle wanted to gift her a sizable chunk of money from his retirement bounty. Also, she has wanted to invest a part of her salary regularly. My cousin understands the value of mutual funds and knows that he should start a systematic investment plan (SIP) for her salary-driven investments. To her credit, he is also aware of the strategy to stagger payments when investing a lump sum.
"So what's stopping you?" I asked.
"I want to pick the 'best fund !" he exclaimed.
That was it. he didn't know how to select his first mutual fund.
So, here's what I told him.
There are no 'best' funds Determining the 'best' mutual fund can be intimidating and subjective. But all you have to do is identify a few that suit your needs.
That said, even this can seem daunting because there are so many options and multiple factors to consider.
You must consider your individual financial goals, risk tolerance, and investment timelines and pick a suitable mutual fund accordingly.
So, I taught Nick a basic framework using which he could choose a suitable mutual fund for himself.
Identifying financial goals
Nick is 25, so his goals include both growth-oriented goals like retirement and children's education fund. He also has capital preservation goals like a down payment on his house or money for a health emergency. For his growth-oriented goals, I made him select an equity-oriented mutual fund. While volatile in the short term, these funds tend to provide better returns over the long haul. For his capital-preservation goals, I made a recommendation for a debt mutual fund . These funds carry less risk and provide steady, albeit smaller, returns. Because he understands his goals well, we also figured out how much money he should invest in each of these funds respectively.
Understanding investment comfort
Nick is a first-time investor, so obviously, he is a little risk-averse. A good idea for Nick is to begin with aggressive hybrid funds for his long-term goals. These funds have about two-thirds in the equity component and the rest in the debt component. They are also less volatile and provide stability. As a result, they balance risk and return well over a long time. But for other investors with some experience in the market, we recommend you look at pure equity funds, provided you are good at handling market swings and have an investment horizon of more than five years. While these funds carry high risk, they often give better returns over the long term.
Determining investment horizon
Investment horizon is the length of time that you can invest before you need to withdraw your money. For instance, Nick's retirement goal is almost 30 years away (goals longer than five years are considered long-term goals). So, he can invest heavily in equity mutual funds. He also needs to account for inflation over these years, another reason equity mutual funds were ideal. These funds will allow him to gain high returns and recover from market fluctuations over time. On the contrary, his short-term goal is to make the down payment on the house. This means that he will need this money within the next three years. So, he should invest in safer, low-return funds.
The decision So finally, Nick began with a good 'aggressive-hybrid' fund for his long-term investment goals. On the other hand, for his short-term goals, he chose a 'short-duration' fund to pay the down payment in around two years.
Also, Nick should review her portfolio after three years, in which he will have gained sufficient experience in the market. It will allow him to make changes like diversification or moving to pure-equity funds over time.
Your takeaway
While solving my cousin's dilemma about choosing the best funds, I realised that this framework applies to all of us new to investing. All we have to do is ask ourselves the three crucial questions and then pick the right mutual fund.
To conclude
Once you have shortlisted your first investments, all you must do is refer to our Analysts' Choice feature. It will help you in selecting top-performing funds in respective categories.
I hope! my efforts on spreading awareness on Mutual Funds,
have fulfil your curiosity.
then waiting for what?
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