How Not To Select A Mutual Fund

Most of us would not buy a new mobile phone just because it looked great from the outside. Before zeroing on a mobile to buy, we would first do a thorough walkthrough of the product. We would look for its battery life, check for its camera quality, the memory, both internal and external, and even its processor so as to know if it supports all the apps that we would want to have in our phones. Just like a mobile phone, investing in a mutual fund also requires a careful and thorough investigation. The fund needs to be researched before committing any fund on it. Just knowing that a fund has been a good performer in the past does not mean that you can put your money in it. Before investing, you need to understand what is inside its portfolio or what philosophy it follows. And more than anything, you need to check what is in the fund’s portfolio.

The above process seems to be tedious and time-consuming one and, hence, many a time,investors take the shorter route to select a MF scheme. They rely on the star ratings, given by different companies. They believe that higher the rating, greater would be the returns, going forward. A lower rating means exact opposite. This is in spite of rating companies giving a clear disclaimer that rating should not be considered as a piece of investment advice. These funds’ returns are relative to other funds in their category. Hence, a five-star rated large cap fund may be underperforming a three-star rated small cap fund, just because of different average returns of both the categories.

Our cover story analyzes how these star ratings are assigned and their irrelevance. Apart from this, our study also highlights that a five-star rating does not guarantee better returns going ahead. On the contrary, we saw that unrated or one-or two-star rated funds have performed better than five-star and four-star rated funds of the same category. Hence, never select the fund based on its current star rating, instead go and ask yourself what does the fund own, how risky has the fund been, what is the expense ratio, and finally who is running the fund? If you find the answer to these questions satiating your needs, you can invest in the fund.