While you go for investing in mutual funds, you get bombarded with options. There is plenty of options in mutual funds which is across market capitalization, time period, risk profile, return profile and so many more factors. Generally, the decision needs to be made between two fund schemes which you are not able to decide from. Hence, it is necessary that you compare the two mutual funds.
WHY DO WE NEED TO COMPARE MUTUAL FUNDS?
Initially, when you start looking at mutual funds, all of them look the same. As and when you go closer and dive deeper into the concepts, there is a great difference on account of several factors taken into consideration.
As challenging it may sound, comparing mutual funds can be highly rewarding later in the long run. Returns are the most widely and commonly used factor in order to compare two mutual funds. there are lot many other things which be and should be considered while making a decision in regard to the selection of the mutual funds. when you count in fund returns, it only gives the difference in the NAV of funds from the beginning and till the end of a particular period depicting only the value addition in the funds. what more needs to be considered is the consistency of the funds, fund house rapport, and risk-adjusted returns. Should you wish to have an appropriate and reliable estimate regarding a mutual fund, you must compare them on these grounds as well.
HOW CAN I COMPARE MUTUAL FUNDS?
Mutual funds can be compared using several ratios and techniques. Start with your investment objective in vision while comparing mutual funds. when goals are clear, the selection becomes quite easier. For example, if one of your goals is earning huge money, then equity funds are the best option for you. Similarly, you can shortlist funds based on other goals.
Following are some of the parameters which can be used in order to compare funds:
Every year, each fund house has to declare the benchmark of its funds as per SEBI’s guidelines. This benchmark is kept into consideration while analyzing performance. You can use this benchmark in order to map the performance of the fund as a scale which tells how much returns the funds has produced as compared to the expected returns.
As a general rule, if the index goes up by 12% and the NAV of the fund goes up by 14%, then the fund is said to have outperformed its benchmark. Inversely, if the index falls by 10% and the NAV of the fund falls by 12%, then it is an indicator of underperformance.
- Investment period
The period under which you wish to stay invested is an important factor to be considered while selecting mutual funds. whichever fund you choose from your selection of funds, it should fall in alignment with your investment horizon. For example, if you wish to build wealth over a considerable period of time (more than 7 years), then equity funds are the best option for you. You must also consider that risk profile remains high while investing in equity funds. on the other hand, if your goal is to invest your surplus money that too for a short period, you can go for liquid funds. liquid funds are better performing as compared to a savings bank account. The broad objective here is capital preservation with moderate returns.
Investing in each and all mutual funds come along with risk. The intermediary must educate the investor regarding the same. While you are still in the process of selecting mutual funds of your choice, you must consider your risk profile in doing so. There are different types of investors based on their risk profile- low-risk appetite, high-risk appetite, medium risk appetite investors.
The risk in any fund accounts to the vulnerability a fund faces when traded in the stock market. It is the difference that occurs in the overall NAV of the fund from the starting of a period to its end. Traditionally, it was believed that high-risk funds produce high returns. But this is not the complete truth. You need to consider many other factors in order to be sure of such a number.
Use of different ratios is done while comparing the risk profile of two funds- alpha and beta are the most widely used ratios. These ratios reflect the rewarding potential of a mutual fund.
While alpha tells about how much extra returns will fund produce over the given period over and above the given benchmark, beta tells about how much risk is involved in investing in that particular fund.
For example, if we talk about two funds X and Y, where their Beta is 1.25 and their alpha is 2 and 2.5 respectively, then fund Y is better as under the same risk profile it is producing higher risk-adjusted returns.
- Expense ratio
Investing in mutual funds is not done for free. You are charged a cost called expense ratio for investing in mutual funds. this cost is used in order to pay the manager and his team managing your fund. Expense ratio has a direct impact on your portfolio’s returns. Since expense ratio is charged as a percentage of your portfolio investment, a higher expense ratio will directly impact your overall returns.
Before you actually put your money into a particular fund, makes sure you have done enough research in order to find out such details.
Note: While comparing expense ratios, make sure you make the comparison between similar funds, direct with direct and regular with regular. Also, the expense ratio of index funds is lower due to low management fees.
While selecting mutual funds, do not forget to check the following pointer:
- Compare funds under the exact same time horizon. 3- year returns of fund A with 3-year returns of fund B and not with 5-years returns.
- Take care of the market cap similarity while comparing. Large-cap with large-cap, mid-cap with mid-cap and small-cap with small-cap.
- Take care of the plan type- growth plan and direct plan