How to Pick Right Mutual Funds?

"Which is the best mutual fund?" The answer to this question is highly nuanced. Finding the right scheme involves a systematic selection process, not just chasing past returns. Many investors ask, "which mutual fund is good" or "which MF is best?"  To answer this question, it is important to know that the ideal fund must align with your personal financial profile. This guide will teach you how to pick a mutual fund by focusing on core principles like goals, risk, and consistency, helping you on how to select the ideal mutual funds that suit your needs. 

Define Your Financial Goals Before Investing

The first step in knowing how to choose a mutual fund scheme is clearly defining your financial objective. Is your goal short-term (e.g., saving for a car in two years) or long-term (e.g., retirement in 25 years)? This distinction is crucial, as it dictates the appropriate asset class and liquidity. Short-term goals necessitate highly stable debt or liquid funds, while long-term goals allow you to explore equity funds for greater capital growth potential. Establishing a clear goal prevents you from investing in a high-risk fund when safety is paramount, ensuring you select the appropriate investment vehicle as per your investment horizon, which is explained in the next section.

Assess Your Risk Appetite and Investment Horizon

Your risk appetite (how much volatility you can handle) and your investment horizon (the time frame for which you plan to stay invested) are the most critical factors in determining which mutual fund scheme is better. 

• Long-term horizons often justify higher risk, as market downturns are temporary, and the potential for compounding is maximized. This often points towards pure equity funds.
• Short-term horizons imply lower risk and stability, making debt or ultra-short duration funds more suitable for such time frames.

An honest assessment here prevents the common mistake of choosing a highly aggressive fund only to sell it at a loss during a market correction.

Compare Different Types of Mutual Funds

The best fund choice depends entirely on your goal. Here is a breakdown of common types that can answer which mutual fund is best for long term or short term goals: 

Category	Primary Goal	Risk Profile	Suitable Funds
Equity Funds	Capital Appreciation	High	Large Cap, Flexi Cap, International Funds
Debt Funds	Income Generation & Stability	Low to Moderate	Liquid, Money Market, Corporate Bond Funds
Hybrid Funds	Balanced Growth & Stability	Moderate	Aggressive Hybrid, Conservative Hybrid Funds
Solution-Oriented	Specific Life Goals	Varies	Retirement Funds, Children’s Education Funds
Passive Funds	Market Returns at Low Cost	Varies	Index Funds, Exchange Traded Funds (ETFs)

 

 

 

 

 

 

 

 

 

By comparing these options, you can get a clear idea on which are the best mutual funds schemes that align with your risk taking ability and time frame of investment.

Check Past Performance and Consistency of Returns 

Past performance is generally seen as a key reference point while deciding how to select mutual funds. But here is the catch: it is not a guarantee of future results. The focus should also be on consistency. Look for funds that have reliably outperformed their benchmark and peers over extended periods (at least 5 to 7 years) and across different market cycles (both bull and bear phases). This demonstrates the fund manager's skill and the robustness of the investment strategy. Avoid schemes that show massive short-term spikes followed by steep drops; consistent, moderate outperformance often proves to be a better indicator of a good mutual fund portfolio holding.

Evaluate Fund Manager’s Track Record and Experience 

The fund manager is the pilot of your investment. When you determine how to select the best mutual fund scheme, assessing the manager's track record is crucial. Look for managers who have:

1. Experience: Ideally, they should have managed the fund (or similar funds) through multiple market cycles.
2. Stability: Frequent changes in fund management can disrupt strategy and performance. Stability often implies a consistent philosophy.
3. AUM: Check the size of the Assets Under Management (AUM) the manager handles. A manager handling a very large AUM may face capacity constraints in certain market segments (like small-cap stocks).

 A seasoned and stable fund management team significantly enhances the probability of your fund delivering its mandated performance over the long term.

Understand Expense Ratio, Loads, and Other Costs 

Costs directly reduce your potential returns, which is why it is important to understand them when deciding how to choose the best mutual fund scheme.

1. Expense Ratio: This is the annual fee charged by the AMC to manage the fund, expressed as a percentage of the fund’s assets. Lower expense ratios mean more of your returns stay with you. This is why many investors prefer the Direct Plan option, which typically has a lower expense ratio than the Regular Plan.
2. Exit Load: This is a fee charged if you redeem your units before a specified time period (e.g., 1 year). Understanding the exit load can help to prevent premature redemptions.
3. Entry Load: These are no longer permitted in India, but it is always a good practice to check if any other transaction charges apply.

Minimizing expenses is essential for maximizing net returns over the long run, especially if you are looking for which mutual fund is best for sip investing, where small savings compound over time.

Decide Between Active vs Passive Mutual Funds 

Choosing between active and passive management is a core consideration when selecting funds. This choice influences both your potential returns and your costs.

Feature	Active Mutual Funds	Passive Mutual Funds (Index/ETFs)
Management Style	Fund manager actively picks stocks aiming to outperform the benchmark	Fund manager simply replicates the performance of a market index
Potential Return	Higher potential returns (alpha) if the manager is successful	Returns generally match the market/index performance (beta)
Expense Ratio	Significantly Higher (due to research and management costs)	Significantly Lower (minimal management required)
Risk	Higher risk, as performance depends entirely on the manager’s ability to select stocks	Lower risk, as there is no stock-picking risk; it mirrors market risk
Best For	Investors seeking market-beating returns willing to pay a premium for taking additional risk	Investors seeking low-cost, broad market exposure and consistent returns

 

 

 

 

 

 

 

 

 

 

 

Conclusion

Knowing how to select the right mutual fund scheme involves more than just looking at the top funds of the month. It requires defining your goals, honestly assessing your risk tolerance, comparing different types of asset classes, and focusing on consistent, long-term fund metrics. By following these steps and minimizing costs, you significantly improve the probability of constructing a portfolio that is suitable for you. If you are uncertain about which mutual funds are good to invest in, consulting a financial advisor is always prudent.

Frequently Asked Questions(FAQs)

How do SIPs help in choosing the right mutual fund? 

SIPs (Systematic Investment Plans) do not help choose the fund, but they make investing easier by allowing you to invest small, fixed amounts regularly, benefiting from Rupee Cost Averaging. This makes the right funds more accessible.   

Should beginners start with equity or debt mutual funds? 

Beginners with a long time horizon (5+ years) should start with a blend, often favoring Hybrid or Flexi-cap Equity funds for growth potential with some moderation of risk.

Can I switch funds if my chosen mutual fund underperforms? 

Yes, you can switch funds, but you should only do so if the fund consistently underperforms its benchmark and peers for 18 months or more. Also remember to check the exit load before exiting any scheme. 

How many mutual funds should an investor ideally hold?

Most experts recommend holding between 5 to 8 well-chosen schemes to ensure diversification without risking "over-diversification," which dilutes returns.

Is it better to choose mutual funds directly or through a distributor/advisor? 

Choosing Direct Plans offers a lower expense ratio. Distributors or advisors provide guidance and planning, which can be valuable if you are unsure about how to pick a mutual fund.