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Things to Know Before Investing in Mutual Funds

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The savings rate in India is one of the highest in the world. Most people tend to stick to traditional savings like gold and fixed deposits and don’t realise that there’s a whole world of untapped potential in mutual funds. This can be attributed to a lack of awareness among the population, but in recent years, the popularity of mutual funds has grown. Consistent returns have made them an enticing option, while mobile platforms and SIPs have made investing in mutual funds a breeze. With this growing popularity comes the need to be thoroughly informed. A lot of people are jumping on the mutual fund bandwagon without a clear understanding, simply because it seems to be the trend. They invest in the same schemes as their friends and family without realising following others may not suit their unique financial journey. Your money, your decisions. If you’re thinking about investing in mutual funds, you’ve found just the guide to equip yourself with the knowledge to confidently pick the schemes that perfectly match your ambitions. 

Factors to consider before investing

Risk Tolerance

Different types of mutual funds have different risk levels associated with them, so it’s important for you to know the level of risk that you’re comfortable taking on. Generally, if you want high returns, you’re going to have to expose yourself to a higher level of risk. In this case, you can consider going for equity mutual funds, especially the mid-cap and small-cap funds. Mid-cap funds tend to be more volatile than large-cap funds and thus have a higher return potential. Small-cap funds are even more riskier since the companies are small and there’s a chance of them not being successful in the long run, but the potential for growth in such companies is extremely high and so is the reward. 

On the other hand, if you’re risk averse and need a more stable option, debt funds would be more suitable for you. Since these funds invest in fixed-income securities such as bonds, they can be a great option if you’re looking for a regular income with low risk. 

Another option is hybrid mutual funds. These funds are a mix of equity and debt-related instruments and are considered a more balanced option. If you want to take on a moderate level of risk, you can look for hybrid funds that invest in, say, 55% equity and 45% debt. 

When you look at different mutual fund schemes, you will find that every scheme document displays a risk-o-meter upfront. You can use this meter to see the risk associated with a particular scheme, and quickly determine if it aligns with your risk appetite.

Investment Goals

Next, you should clearly and specifically define your investment goals — Why are you investing? Do you want to invest for retirement, buy a new car, fund your children’s education, or simply create wealth? The amount of time it will take for you to achieve each goal will vary, so the time horizon of the fund you choose should align with your investment goals. If you want to invest for your retirement, that means you want long-term growth, so consider long-term mutual funds. If your goal is to generate income, go for income funds, which is a category of mutual funds that invest in bonds and pay out a regular income. Your goals will shape the type of funds you should invest in. 

Performance History

It’s important to do your research. Before you commit, review the historical performance of the mutual fund. How did it perform over the last year? Over the last five years? The last ten years? How consistently did it perform? Compare the fund’s returns to its benchmark. If the scheme consistently lags behind its benchmark over an extended period, that means the fund may not be meeting the expected results. 

Of course, it’s not possible to predict the future and what the performance of the fund will be like, but analysing its history and trends can give you some valuable insights into how the fund has performed in different market conditions – favourable, and unfavourable. Analyse how consistent and resilient it was when the market was fluctuating and remember, if a fund has done well in the past, that does not guarantee that it will do so in the future. 

Fees and Expenses

There are various fees and charges associated with mutual funds, such as exit load, expense ratio, sales charges, and other nominal transactional charges. Exit load has to be paid if an investor exits a mutual fund prematurely, and sales charges are paid to the advisors or brokers as a commission. Annually, an expense ratio is charged by mutual funds which includes the management and administrative costs. It represents the expenses of operating the fund relative to the assets as a percentage, usually somewhere between 1-2%. Compare the expense ratios of different schemes before you make a move because you’ll get a higher net return on a low expense ratio. Having proper knowledge of all the expenses involved is vital because high fees can make a big dent in your returns over time.

Fund Manager’s Track Record

The fund manager is responsible for directing the fund’s strategy. One of the biggest advantages that come with investing in mutual funds is that they are managed by a highly trained professional or a team of professionals, and that fact brings peace of mind to the investor. A skilled and experienced manager can contribute to a fund’s success, and you should take a deep dive into the track record of the fund manager. Research their investment philosophy – Are they an active manager or a passive one? An active fund manager is extensively engaged and tries to beat the benchmark index and generate higher returns, making them more suitable for investors with higher risk tolerance. A passive manager on the other hand tries to mimic the benchmark index and is more in line with your philosophy if you’re risk averse.

Tax Implications

Tax can significantly impact your net gains so it’s important to be mindful of taxes when you’re planning your investments. Different types of mutual funds have different tax implications so if your goal is to minimise your tax liabilities, look for mutual funds that offer tax benefits such as Equity Linked Saving Schemes. Under Sec 80C of the Income Tax Act, you can get a deduction of up to Rs. 1,50,00. Another advantage of ELSS is that out of other tax-saving investment instruments such as the Public Provident Fund, it has the shortest lock-in period of three years. 

The time you intend to stay invested is also important as far as tax goes as depending on that period, you will be liable to pay tax on short or long-term capital gains.

Exit Load

Exit load is a charge that some mutual funds impose on investors who prematurely redeem their units. This is done primarily to discourage investors from backing out before a specified period, and the percentage charged varies from fund to fund. You’ll find the exit load, if any, on the scheme-related document so carefully study them because it can affect your net profit.

Mutual Fund Match-Making

Finding the best mutual funds is a lot like the matchmaking process. When matchmakers or family members set out to find suitable matches, they look for compatibility. Compatibility in terms of goals and aspirations, personalities, lifestyles, interests, values, and some socio-economic aspects. The goal of matchmaking is to find and create a meaningful connection between two people so that they have a lasting and fulfilling relationship. Similarly, when you’re investing in mutual funds you have to play the matchmaker in order to make sure both you and the fund are compatible for a successful and fulfilling investment journey.

To find your right fund, make sure that:

  • Your goals align with the fund’s goals.
  • Your risk profile aligns with the fund’s risk-o-meter. You’ll find the risk-o-meter clearly displayed in the scheme documents. It has six levels – Low, Low to Moderate, Moderate, Moderately High, High and Very High. 
  • Your time horizon matches with the funds. A long-term mutual fund is not the answer if you’re investing with the goal of going on a vacation. 
  • Your expectations are in check. Is the fund expected to deliver the returns that are in line with your expectations? If a fund has consistently returned 10% in the last five years, you cannot expect it will suddenly jump up. It might, but don’t bank on it. Do this and you will save yourself a lot of anxiety and frustration, and you won’t be tempted to redeem your units prematurely.

Follow these simple rules and you’ll find the fund best suited to you. 

Do the background check on the fund’s reputation 

But of course, it doesn’t end with matchmaking. After matchmaking, a little research is done about the potential partner. You verify what you’ve been told, like age, education, and family background. You do a financial check to know the state of the potential partner’s personal finances, salary, and liabilities. You check for any previous marriages or divorces, or any criminal record. It’s a thorough process, and why not? It’s going to significantly affect many lives. Similarly, you have to be thorough with your background check on the mutual fund. This is how you go about it:

  • Analyse the fund’s performance over several years. What you’re looking for is consistency. A fund giving a very high return in one year and a small negative return in the next is not as good as a fund that can give a consistent return over a period. If it’s too erratic, it’s harder to recover losses and if it’s consistent it will have overall better and stable returns over the long term. 
  • How a fund performs is just the outcome of the investment management process. Check the strategies, philosophies, and decisions of the fund manager while managing the fund. Choose mutual funds from fund houses that have a very well-laid-down transparent process. A systematic and thoughtful investment process will lead to a solid fund performance over time. You can also check if the fund house is backed by an institution. Usually, institutional backed fund houses are more reliable but remember that being backed by an institution is not a foolproof way of assessing the quality of the investment process. Do a detailed research. 
  • Assess the volatility level of the fund, which means how significant its price fluctuations were over short periods. Check the Sharpe Ratio of different funds. This ratio can help you understand the return generated by an investment relative to its risk. It evaluates the performance of an investment while considering the risk that comes with it. If a fund has a higher Sharpe Ratio, it means that the fund has delivered better returns relative to its risk.
  • Finally, investigate any ethical concerns within the fund house. Their operations and fees should be transparent, they should comply with the regulations, and not raise any red flags. Check the news and stay updated about them to make sure they’re not involved in any shady practices. See if any fund managers have a history of taking irrational or erratic investment bets because that can be a conflict of interest. You wouldn’t want to be associated with a fund house that doesn’t uphold high ethical standards and sound financial practices.

If the fund is compatible and satisfies the background check, well Shaadi Mubarak Ho! You’ve found your perfect match, but your job doesn’t end here. Regularly review the investments you’ve made and make sure you’re still compatible. When things change, review and realign your portfolio as necessary. Remember, times have changed, now marriages don’t last seven lifetimes. If the periodic review suggests a violation of any of the set values, then it would be better for you to break free.


Starting a mutual fund journey can be very exciting. You now know all the essential factors that you need to keep in mind before you select your mutual funds, as well as the process to make sure they are perfect for you. Align your goals and risks with the fund’s, do a thorough background check on its performance and manager, stay informed about the tax obligations, and read all scheme documents carefully. With this knowledge, you can confidently make your own decisions and achieve your goals.

Sometimes market fluctuations can make people nervous, especially people who are new to the investment game. In that nervousness, they can make hasty and suboptimal decisions that they might regret later. If you do your due diligence before investing, you’ve got no reason to be nervous. Trust your strategy and assess the situation regularly – be ready to back out if your review suggests that the fund no longer serves your financial well-being. Seek advice from your financial advisor if you’re unsure so that they can guide you in the right direction and keep you informed about your investments.

Happy investing!