How to select Mutual Funds?
Investing for long term helps ONLY when you are investing at right time. What does "Right Time" mean!!!
Example 1: Anyone who invested in late 2010 or early 2011 in equities, most likely are feeling the pain as their portfolio would be in RED (losses) by 2012
Example 2: Anyone who invested in early 2009, would be very happy to see their portfolio in GREEN (profit) by 2010/ 2011
Above examples shows that timing is critical for long term investment. Investing in wrong financial instruments at wrong time can cause major damage to your financial portfolio. Assuming you have read earlier sections where we explained how to read market direction, now you know how to identify where the market is headed. You can also follow our blog on weekly basis for updates.
Step by Step:
1. Identify market direction and get a feel for where the markets are headed in near future as well as where the markets are in long term cycle. This will ensure that you do not enter the market while it is at the TOP but rather you are entering while the market is coming out of correction or pullback.
2. Identify which funds to select? (Use FundsIndia or Moneycontrol fund screener - easy to use)
Market is in uptrend [BULL market] and currently undergoing correction or pullback: Choose All Equity Funds
- Wait for market to come out of correction/pullback (you can see this on the charts)
- Since we are investing for long term (minimum 1 year to avoid capital gains tax), we want to make sure that the fund is safe to invest as well as have good ratings. Also we would like to see fund performance hence the fund needs to be in existence for at-least 5 years. Use above mentioned screen-er to find top three to five funds (typically choose the top ranked fund in 3month/1year/2year/3year/5year time frame - select one from each time frame).
- Now use MoneyControl Funds Compare tool to see each funds performance visually in comparison to each other as well as with the Sensex. This is what you should look for. Check fund performance for last 3 months / 1 year / 3 year / 5 year. Understand, how each fund performed during market uptrend and downtrend. Typically, equity funds perform well during up trend and perform bad during down trend.
- Remember, 1 year is a minimum time you need to hold the fund to avoid tax. In short you can sell the Mutual Fund after 1 year and take the profit tax free, hence it is essential to check which fund did best during market uptrend to maximize your profits. DO NOT FORGET that you can still get out of funds (before 1 year with some fees) if you sense markets are behaving bad and could result in financial crash).
- Besides above factors, you can also check factors such as Fund house, Fund management, Fund size, etc.
Market is in downtrend [BEAR market] and NOT currently undergoing correction or pullback: Choose All Debt Funds
- Wait for confirmation for change of trend. BEAR market does not mean a pull or correction. Market downtrend which started in late 2010 til December 2011 (more than a year) constitutes BEAR market.
- For debt funds the taxation might be bit different so please check with your tax accountant before making any investments.
- Follow all other steps as mention above.
3. Once you identify that market is changing trend then that will be the time to get out of the Funds. Hence it is very important to invest for long term during market trend change. Timing is critical for success.
How to select Tax Saver Fund?
- Minimum hold/lock-in period of 3 years
- Compare funds and check performance for last 3 years/5 years. We are fortunate that Market was in downtrend for a year (entire 2011) and prior to that it was in uptrend. This helps us to check how each fund performed during uptrend as well as downtrend.
- Select fund which performed better in bad market as well as performed good in market uptrend.
- NEVER choose to do SIP (systematic investment plan) especially for Tax Saver Fund as you will only be able to remove your investment without any penalty after the 3 year period for that part of investment. e.g. We started SIP (each month we invest 1000) in a Tax Saver Fund starting from January 2009 then we can remove that investment (Rs. 1000) only after January 2012. Since this is monthly SIP investment, we cannot remove rest of investment in January 2012, instead we will have to wait every month to remove the amount.
Should we invest using Systematic Investment Plan (SIP)?
Everyone suggests to do SIP, does it mean we should do it!!!
SIP is typically done for following reasons:
- We do not have enough capital to invest at the beginning of the investment. Since a certain amount automatically gets allocated to a certain investment plan and we do not have to worry about it.
- We do not understand how markets work!
- We are lazy to take efforts to understand market and wants a simple method.
- Gives us a simple method to save and invest at the same time.
We hope this helps you to make better long term investments in Mutual Funds.