As mutual funds continue to grow in popularity as a viable investment option, many new investors are joining the mutual fund bandwagon. However, it is crucial to know how to select the best mutual fund before beginning your investment journey.

A steady economy, rising income, and better financial awareness levels have contributed to the rising popularity of mutual funds. But, when there are so many options, it can be challenging to spot the right mutual fund.

However, you can easily know how to select the best mutual fund using the steps discussed herein.

Crucial Steps Involved in Mutual Fund Selection

• Set Your Financial Goals

  The first step before embarking on your mutual fund investment journey is to set clear financial goals. For example, you may have short-term goals like purchasing a car next year, going on a holiday, and so on. On the other hand, you might have long-term goals like retirement planning, purchasing a house, etc.
  
  You can know how to choose the best mutual fund if you have set a clear purpose for your investments. Use the following questionnaire to arrive at your purpose.
  
  - For how long can you stay invested?
  - How much would you like to invest regularly?
  - Are you investing for wealth creation, preservation of capital, or both?
  - Do you want tax benefits on your mutual fund investments?
  
  You can add more questions to the above list if you like. The mutual fund selection process will become easier once you know your investment goals.
  
  Also Read – What is Mutual Fund?

• Analyse Risk

  Analysing the risk factor is crucial to learn how to choose mutual funds, as risk levels vary with fund types. Read the fund’s offer documents to understand the level of risk involved.
  
  For instance, equity mutual funds invest a significant part of their investment corpus in equities and equity-related instruments. As a result, investors in equity mutual funds are more prone to market volatility, especially in the short run. However, they also carry the potential to provide high long-term returns possibly. Therefore, these funds may be suited to investors with a high-risk appetite who are looking to generate wealth in the long term through capital appreciation.
  
  Also Read - What is Equity Fund?
  
  On the other hand, debt funds can be suitable for risk-averse investors. These funds invest predominantly in debt instruments like government bonds, treasury bills, etc. Therefore, returns are relatively stable than equity funds. On the flip side, debt funds are known to come with a lower return potential than equity funds.
  
  Also Read - What are Debt Funds?

• Flexibility

  Consider the level of flexibility you desire in accessing your investments. Unlike the Equity Linked Savings schemes with a 3-year lock-in period, most mutual funds usually provide high flexibility. It means that you can enter or exit your investments at any time. But, you may have to bear an exit load if you redeem your fund units before the minimum duration specified in the scheme's offer documents.
  
  While the process of redemption is very easy, it is advisable to stay invested in mutual funds for longer. This helps you ride through the short-term market volatility and gain from the power of compounding.

• Understand Investment Approach

  Every mutual fund follows a different investment strategy. For instance, while an equity fund may put more stress on acquiring stocks with high growth potential, another one may go with stocks with strong financial fundamentals.
  
  Consider investing in a fund whose investment strategies suit your investment philosophy and your risk appetite. This can help you stay with the fund for a long time and build a well-diversified portfolio that enables you to achieve your financial goals.

• Study the Fund’s Performance

  While a fund’s past performance doesn’t guarantee its future earning potential, it is a good way to assess the quality of the fund. However, don’t assess the short-term performances, like the past one or two quarters. Instead, check the fund’s performance over an extended period, say 5+ years. Find out how the fund faired across different market cycles.
  
  Look for some positive signs like
  
  - Consistent/Stable returns for a long time.
  - An experienced fund management team with a sound track record.
  - Outperforming the benchmark index over three, five, or more years.
  
  Click here to Visit - Index Funds

• Consider Expense Ratio

  Mutual funds charge investors a small amount of money as a fee to manage their investments. It is called the expense ratio. Although the expense ratio may appear to be a tiny percentage, it can be significant considering your total investment portfolio.
  
  Therefore, ensure that you know the fund’s expense ratio well. However, don’t blindly select mutual funds with a low expense ratio. Consider the fund’s reputation and overall performance as well.

• Purchase Direct Plans

  A mutual fund scheme can have two different versions- Direct Plan and Regular Plan.
  
  If you purchase a mutual fund directly from the fund house, it's a direct plan. If you purchase the same scheme through an intermediary like an authorised agent, broker, etc., it's a regular plan.
  
  If you purchase direct plan of a mutual fund, it can help you save on commission expenses. You can purchase the direct plan by visiting the fund house’s office or its official website.
  
  Also Read - How to Invest in Mutual Funds?

• Check the Entry/Exit Load

  Entry load is the fee charged by the fund house to the investors when they join the scheme. However, most reputed fund houses don’t charge entry load.
  
  Exit load is the fee investors pay if they exit the mutual fund before the minimum investment duration stipulated in the scheme's offer documents. Investors should consider mutual funds after carefully evaluating the fund's entry load and exit load.
  
  Must Read - Exit Load in Mutual Fund: Meaning, Types, and Calculation

• Taxes Involved

  Mutual fund returns are taxable as per the income tax act. They attract long-term capital gains (LTCG) tax or short-term capital gains (STCG) tax on the gains based on the investor's holding period.
  
  

  Type of Fund	Holding Period
  	Long Term Capital Gains Tax	Short Term Capital Gains Tax
  Equity-Oriented Fund	12 months or above	Less than 12 months
  Debt Fund	36 months and above	Less than 36 months

Currently, the LTCG on equity mutual funds attract an income tax of 10% (plus surcharge and cess) over and above the exemption limit of ₹1 lakh. An income tax of 15% (plus surcharge and cess) is applicable to STCG.

Capital gains realised on debt funds are subject to indexation benefits. Indexation considers the inflation rate to adjust an investment's purchase price. So, you can use the indexation benefit to bring down your tax liabilities if you hold a debt fund for a long period. LTCG on debt funds should be taxable at the rate of 20% (plus surcharge and cess) with the benefit of indexation. STCG on debt funds should be taxable as per the respective Income-tax slab rate applicable to the individual.

Investing in mutual funds can help you unlock the full potential of your savings. They can also help you potentially generate long-term wealth if you stay invested for a long time. So, now that you know how to choose mutual funds, don’t delay your investment journey any further. Also Read - How to Track Mutual Fund Investment

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.