Picking a mutual fund can be intimidating, especially when many funds give good returns. But the best returning fund is not always the best fund to invest in.
Before you invest, it’s important to look beyond the historical performance and evaluate a number of factors that impact returns. Here are 8 things to check before picking a mutual fund.
Why Evaluating Mutual Fund Returns Matters
Here are some important parameters to consider while analysing mutual fund returns before you decide to invest.
1. Compare Returns With the Benchmark
Every mutual fund is associated with a benchmark index that represents the market segment in which it invests.
For example, the NIFTY 50 can be used to compare a large-cap equity fund. A fund that consistently beats its benchmark over time can be a sign that the fund is being well-managed. A fund that has consistently underperformed its benchmark deserves closer scrutiny.
2. Evaluate Risk-Adjusted Returns
Mutual funds have certain risks. Investors should check different metrics to evaluate that.
For example, metrics such as the Sharpe Ratio help investors understand how much reward a fund provides for the level of risk it takes. So the higher the Sharpe Ratio, the better the risk-adjusted performance.
3. Review Rolling Returns Instead of Trailing Returns
A lot of investors only think about trailing returns, which measure the value of a fund between two specific dates.
Rolling returns provide a wider picture as they reflect returns over multiple periods. This method avoids recency bias and allows for a better understanding of the fund’s performance in different market environments.
4. Check Performance Across Different Time Horizons
Just because a fund did well last year doesn’t mean it will do well over longer time horizons.
Review returns for one-year, three-year, five-year and ten-year periods, where possible. Quality is often better indicated by long-term consistent performance than short-term gains.
5. Understand the Expense Ratio
The expense ratio is the annual fee charged by the fund house to manage the scheme.
Even small differences in expenses can be magnified by compounding over a long period of time. By keeping expenses low, investors can keep more of the gains from their investments over time.
6. Analyse Maximum Drawdown
Maximum drawdown is the largest decline a fund has experienced from its peak to its trough during a specified period of time.
This measure gives investors a sense of how the fund performs in a down market. Some funds with less drawdown may afford better protection on the downside in volatile market conditions.
7. Review the Fund Manager’s Track Record
Experience and consistency of fund managers can be important to performance.
Look at the historical returns and see if the same fund manager delivered those returns. Management changes can be frequent and affect investment strategy and future performance.
For instance, if you are an investor looking for HDFC mutual funds, then you should check the scheme’s past performance and the experience of the fund management team.
8. Use Investment Tools to Estimate Future Growth
Past returns can provide useful insights, but investors should also estimate potential future outcomes.
A SIP return calculator helps you to compute the future value of your regular investments based on expected returns and investment duration. Projections are not a sure thing, but can be useful in financial planning and investing decisions based on goals.
Conclusion
To compare mutual fund returns, you need more than just a glance at the fund with the largest gains.
Before investing, investors should compare benchmark performance, consider risk-adjusted returns, review rolling returns, analyse expenses and understand downside risk.
Use this checklist to help you make better investment decisions and select mutual funds that align with your financial goals, risk tolerance and investment horizon.
