Why Do We Need to Compare Mutual Funds?

We’ve always been taught comparisons are wrong. Moreover, we know for a fact that they are wrong. You can’t compare yourself to another, and so much more in the context of this. But this isn’t a psychology article – it is a financial one. Here, we are taught that comparisons are not wrong. They are great, in fact. 

You must compare mutual funds before buying them. It’s a big must, you see. This is part and parcel of the evaluation. Also, a secret to great returns. 

Why Should You Compare Mutual Funds?

You may have come across a multitude of mutual funds that offer numerous rewards for a small investment. However, in the initial instance, all of the funds in a given category appear to be the same. This makes making sound decisions difficult. 

After all, investing is a long-term endeavor, and you should be informed of what you’re getting into. Most investors use fund returns as the sole criterion for measuring and comparing fund performance.

Fund returns are defined as the difference between the Net Asset Value at the start and the Net Asset Value at the end of a certain time period. Annualized returns only reveal the value addition/reduction over a specified time period. But what about return consistency, fund house quality, and risk-adjusted returns? You must compare mutual funds on these criteria as well while selecting the proper investment. You will be able to make the appropriate decision if you use some of the financial ratios.

For instance, let’s say you directly choose to invest in the DSP Blackrock mutual fund. Someday, you see that a mutual fund of the same period and price hits higher levels – was that the market’s fault or yours?

Now that you know the why – it is time you know the how. We always need the answer to both these questions, don’t we?

How to Compare Mutual Funds?

You must conduct mutual fund research and compare mutual funds using the following parameters:

a) The Objective

There are dozens of equity programs with various investing goals. Large-cap, mid-cap, small-cap, and multi-cap funds are some of the equity fund categories. There are also value funds, contra funds, and sectoral funds. They are all equity-oriented mutual funds with varying investment objectives.

Similarly, there are numerous debt mutual fund programs. When comparing two or more mutual fund schemes, you should be aware of their investing goals.

b) The Risk

In terms of risk, not all equity mutual funds are created equal. Small-cap equity mutual funds are riskier than large-cap equity mutual funds. The riskiness of a given mutual fund is determined by the underlying investments it makes.

You should compare mutual funds based on their risk and select the mutual fund scheme that meets your risk tolerance.

c) The Returns

Every mutual fund is linked to an index or benchmark. The benchmark aids in comparing the performance of mutual funds across time.

Assume equity mutual fund A is benchmarked against the Nifty 100 total return index. Keeping all other parameters constant, if the index gains 18% and fund A gains 20% over a given period, the fund has outperformed the index.

If the index falls by 10% and fund A falls by 12%, fund A has underperformed for the given period. Choose a mutual fund plan that has consistently outperformed its benchmarked index.

d) The Charges

The expense ratio and exit load are fees you pay to a fund house when you invest in mutual funds. The loads cover the costs of management, redemption, and mutual fund administration.

It is preferable to invest in a mutual fund with a lower exit load and expense ratio. However, a reduced expense ratio in a mutual fund does not imply that the fund will generate higher returns for you. Even if the burden is slightly higher, you should choose a mutual fund with higher returns.

e) The Portfolio Balance

You can also compare a mutual fund’s portfolio to that of its peers. You can compare fund allocation by market cap, number of securities invested in, portfolio holdings across sectors, and so on. You can also compare funds’ modified duration, average maturity, and YTM.

f) The Tenure

The length of your investing horizon influences fund selection and comparison. Equity funds may be appropriate for investors having a long investment horizon of at least 5-7 years or more. During this time period, the fund’s goal is wealth accumulation at a somewhat high risk.

Similarly, when it comes to investing extra funds in the near term, liquid funds outperform savings bank accounts. The fund’s goal, in this case, is capital safety with moderate returns. In this context, while comparing mutual funds, compare mutual funds with time periods that correspond to your investment horizon.

Investors must have a long time horizon when investing in equity-oriented ETFs (of at least 5-7 years). Simple math demonstrates that the longer your investing horizon, the more risk you can accept and the more time you have to recover your losses.

It means that while comparing two equities funds, you can take into account fund results over the last 5 to 10 years. Similarly, when comparing two liquid funds, examine fund returns from the previous six months to one year. Choose a mutual fund strategy that has regularly outperformed in the long run.

Conclusion

In India, there are around 8000 mutual fund plans. Choosing the best mutual fund for your financial goals, investment horizon, and risk tolerance is a daunting undertaking. Furthermore, mutual funds in the same category appear to be very comparable. This may perplex you. You might select the incorrect mutual fund plan. Mutual fund comparison can assist you in determining the differences between them.

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