7 Important Points to check before Investing in Mutual Funds

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Mutual funds have emerged as one of the most promising investment tool in the past couple of years. A lot of people have started investing in mutual funds through the SIP and lump-sum route.

The increase in popularity of mutual funds is not only due to the fact that they have the capability to return superior returns but also due to the fact that there is no minimum/ fixed commitment and a person can invest with as low as Rs. 500.

Moreover, as opening a demat account has also become a lot easier, people are now preferring to invest in these funds through their demat account itself as it offer a lot of convenience as compared to holding them in paper form. Convenience coupled with lucrative returns is what is driving more and more investments in Mutual Funds.

Despite the fact that the Mutual Funds are subject to Market Risks, they continue to gain popularity and a lot of people have started regularly investing in them as they have a good potential to earn a higher return.

This increase in popularity of mutual funds has also led to launch of various new mutual fund schemes. However, not all mutual fund schemes are the same. These different schemes have different objectives and before investing in any, the investor should check the following parameters and make his investment decision accordingly.

Things to check before investing in Mutual Funds

  1. NAV of Mutual Fund and it’s existence

A new mutual fund scheme would be priced at lower rate whereas an already existent mutual fund scheme would be priced at a higher rate. Just because the new mutual fund scheme is priced at a lower rate does not mean that you invest in that scheme as it looks cheaper.

The current NAV of any mutual fund never impacts its future earning potential and an investment should never be made on the single criteria that it is cheaper.

Infact, rather than the price – importance should be placed on the existence of the mutual fund scheme. If the mutual fund scheme has been in existence for several years and is delivering a good return – this proves that the management is skilled and experienced.

Although future returns may not be replicate the previous returns, but it gives some idea on the capability of the management.

  1. Mutual Fund Manager

Apart from the checking the previous return of the mutual fund, it is also important to check who the fund manager is and what has been his performance in the past.

The mutual fund scheme may change its manager and in such cases – the past performance of the mutual fund may not be the same as the past performance of its manager.

And therefore, the past performance of the mutual fund manager and his investment style is also an important criterion to be checked before investing in any mutual fund scheme.

  1. Tax Benefits

Not all mutual funds are entitled for deduction under Section 80C. Only those schemes which are Equity Linked Saving Schemes (ELSS) are entitled for tax deduction under Section 80C.

Therefore if the investor intends to claim Section 80C benefit he should invest in ELSS only. Such funds are also sometimes called as Tax Saving Mutual Funds as it makes it easier for the investor to figure out whether 80C Deductions can be claimed or not.

At the time of sale, tax would be levied on all types of mutual funds but at the time of purchase – Sec 80C Tax Benefits can only be claimed for investment in ELSS Funds which are also sometimes referred to as Tax Saving Mutual Funds.

  1. Check the Investment Allocation

The mutual fund manager may either invest the funds collected in equity or in debt.

The potential to grow is much higher in case of equity as compared to debt. However, equity is also risky as compared to debt. As equity is considered risky, therefore the return potential of equity is also much higher.

While investing in any mutual fund – the investor should check the investment allocation i.e. how much the fund manager is investing in equity and how much the fund manager is investing in debt. And based on how much risk the investor is willing to take, he should accordingly shortlist the mutual fund scheme.

  1. Exit Load

A load is a charge put in by the mutual fund scheme at the time when the investor withdraws the money from the mutual fund scheme before a specified duration. Although most mutual funds don’t have any exit load, however some mutual funds levy an exit load of 1% if the investor withdraws the funds before 1 year.

It is important to check the exit load of the mutual fund as this will impact the returns which you get from the mutual fund if you withdraw before the specified duration.

  1. Lock-in period

Apart from exit load, another thing to be checked is the lock-in period. Some mutual funds have a lock-in period and during this period the investor is not allowed to withdraw the funds.

Even if the investor intends to pay exit load, he is still not allowed to withdraw the funds before the lock-in period. The tax saver mutual funds are one such example of funds which come with a lock-in period of 3 years which is a mandate given by the govt.

  1. Volatility Measure

The volatility measure of the scheme gives an idea on how the fund has been performing during different time periods.

While short-listing a mutual fund scheme, the investor should compare the fund performance with the benchmark indices like Sensex, Nifty etc and also with the other shortlisted funds.

This will give the investor an idea on how the fund has been performing in the past and if it is the correct fund for you.

Although past returns have no impact on the future earnings potential of any mutual fund scheme, however, the above mentioned parameters will give you an indicative idea about which mutual fund scheme is expected to perform better in the future.

Moreover, these parameters will also help you choose the funds which meets your preferences and helps you meet your financial goals.

Karan is CA by Qualification with the rare distinction of being awarded All India Rank 22. He is also the founder of this website and is an expert in helping people save Taxes legally. He can be reached by booking an appointment for Tax Advisory Service.