How to choose the right mutual fund?

Mutual funds are a handy instrument for investment for those who don’t have the time and bandwidth to research individual stocks. They function on the principles of shared risk as several people buy units of a mutual fund. However, there are several categories and innumerable schemes under those categories which make choosing funds an arduous task. Hence, we discuss the broad categories of various mutual funds and how you should decide which one to invest in.

The primary categories of mutual funds are

  • Equity funds-these funds comprise stocks of various kinds
  • Debt funds- these funds hold government and corporate bonds and bills
  • Hybrid Funds- these funds have a mix of equity and debt

Equity funds are divided into 3 primary categories

  • Large-Cap Fund: Holding stocks with a market cap of > $10billion
  • Mid-Cap Fund: Stocks with a market cap from $2 billion to $10 billion
  • Small-Cap Fund: Stocks with Market cap<$2 billion

Large-cap, mid-cap and small-cap funds

Large-Cap funds usually hold massive established companies like Amazon and Google. Midcap funds hold stocks with growing market capitalization but which are more volatile than the established large-cap stocks. The Small-Cap funds hold up-and-coming companies which have the scope of providing monumental returns but also hold the risk of intense volatility.

Debt funds

Debt Funds as mentioned earlier comprise corporate and government bills and bonds. They are categorized primarily based on their time to maturity. Few examples are Ultra-short duration, short duration, long-duration bonds. Hence an ultra-short duration fund may hold 1y bonds while a long-duration fund may hold 10y bonds.

Hybrid funds

Hybrid funds consist of both equity and debt funds and allocate them in either a balanced ratio or keep it dynamic.

Equity funds

Equity funds have other themes too like value funds, sectoral funds, etc but it’s important to have a good understanding of the basic ones first, and then it is easier to diversify if needed. While investing in a mutual fund you should keep note of mainly 3 things, your risk appetite, period, and diversification.

What is the best choice for you

If you have a good risk appetite, you can go ahead and invest in small-cap equity funds. But if you are a bit risk-averse and would prefer more stabilized returns, large-cap is for you. If you want a balance between the risk of equity and the security of debt, hybrid funds are your go-to.

If you plan to withdraw money from the fund in a short period, the yield on debt funds and the exit load of the fund becomes important. Similarly, if you wish to keep some cash handy and quickly remove it without having to pay an excessive commission on taxes, you could consider having 30% in the debt fund without bothering much about the returns and the rest of it in equity.

These decisions are to be evaluated by you. There is no right or wrong. Use the aforementioned guidelines and evaluate where you stand. Understand and revisit the purpose of your investment and you will have a lot of clarity in front of you.