How to select an equity mutual fund -preamble

Over the next few days, I would like to do a series on “How to select an equity mutual fund”. This is the long overdue update to the step by step guide to mutual fund selection.

I write this primarily because my understanding about  mutual funds has grown significantly since I wrote the pdf guide. I have already shared this with you in the form of analysis and calculators. Would like to consolidate it in terms of specific steps.

In this post, I would like to start with a preamble which will define the objectives and the framework of what will follow.

The central objective is quite simple: To enable anyone to select a mutual fund in about 20-30 minutes. This time will reduce significantly once the investor gets a better grip on the method.

There are however a few necessary prerequisites to make the selection process easier.

The following and ensuing posts are valid only for long-term goals that is 10 years or more away.

1) A financial goal is mandatory. Questions like, “why am I investing?” and “when do I need the money?” should be answered.

2) What is the proposed asset allocation? For a given goal and duration, how much will the exposure in the equity fund that you would like to select be? This is crucial because many people make the mistake of investing in 100% equity for long-term goals. The equity:debt (fixed income) allocation is mandatory.

3) What is the expected return from the equity mutual fund for the investment duration? Personally I will use 10% for calculating the investment amount and expect about 12%. Do not expect more than 15%.

4) Expected return from total portfolio  = (expected return from equity) x (equity allocation) + (expected post-tax return from debt) x(debt allocation)

5) Use the expected portfolio return in a standard goal planner with about 10% inflation for all goals expected retirement. For retirement use a minimum of 8% inflation. With other inputs found in the goal planner, you should be able to determine the necessary monthly investment. Even if you are not able to invest as much, this step is necessary to understand the requirements of the financial objective.

6) Decide about the debt portfolio. For goals which are 15 financial years away, PPF is a good choice. EPF or mandatory NPS will do fine for retirement. For other goals, you can consider short-term debt mutual funds.

7) Decide about the equity portfolio. There are many ways to do this. I prefer minimalist portfolios

I prefer 60% in large cap and 40% in mid and small caps. So one large cap fund and one mid and small cap fund is all that you need. You can also opt for a single large and mid-cap fund.

A single equity-oriented balanced fund will also work fine. In which case you need to take care of overall equity:debt asset allocation.

Once you have decided how you are going to construct your portfolio and what mutual fund categories you are going to choose, you are all set to pick a fund to invest in.

Those who have already started investing but have not performed any of the above steps, can do so now. Better late than never.

There are many ways to select a mutual fund. I would like to present three ways to do it.  I do not qualitatively analyze a fund too much. If the fund is good, I believe it should show up in the NAV movement. So for the most part I treat a fund as a black box. However, I ensure  that is label on the box is the one I want.

Here are the methods to be discussed. Regular readers will understand where I am going with this.

Method 1:  This is identical to mutual fund guide published earlier. Short-list funds based on consistent performance and then consider risk-return metrics for last 3 years.

Method 2: Short-list funds based on consistent performance and then consider risk-return metrics for longer durations either based on investment duration or for each year.

Method 3: Short-list funds based on consistent performance and then consider downside protection and or consistent long-term rolling returns.

You can save this post as a pdf document with the button below.

Part 2: How to select an equity mutual fund – Creating a shortlist

 


About the Author M Pattabiraman author of freefincal.comM. Pattabiraman is the co-author of two books: You can be rich too with goal based investing and Gamechanger. “Pattu” as he is popularly known, publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis, including a robo advisory template for use by beginners. Contact information: freefincal {at} Gmail {dot} com He conducts free money management sessions for corporates (see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints.

Content Policy

Freefincal has original unbiased, conflict-of-interest-free,  topical reports, reviews, commentary and analysis on all aspects of personal finance like mutual funds, stocks, insurance etc. All guest authors and contributors to the site also do not have any conflict of interest. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. No promotional content We do not accept sponsored posts and link exchange requests from content writers and agencies. This is our privacy policy Our website is non-profit in nature. The revenue from the advertisement will only be used for hosting charges, domain registration charges, specific plugins necessary for traffic growth and analytics services for search engine optimisation.

Create a "from start to finish" financial plan with this unique open-source robo advisory software template


 Don't like ads but want to support the site? Subscribe to the ad-free newsletter! 
You will get the full post-ad-free delivered to your inbox for Rs. 3000 a year. Follow this link to read the terms and sign up! 
Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; where to invest; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. I can do the talk via conferencing software, so there is no cost for your company. If you want me to travel, you need to cover my airfare (I live in Chennai)

Connect with us on social media


Do check out my books


You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingMy first book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.  It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You WantGamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantMy second book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

The ultimate guide to travel by Pranav Surya

Travel-Training-Kit-Cover This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.
Updated: January 4, 2016 — 7:36 am

9 Comments

Add a Comment
  1. Dear Pattu Sir,

    thanks a lot for re opening the subject…. eagerly expecting the guide soon….

    wishing you most and more…

  2. Respected sir;how do you manage to explain complex financial concepts in such an easy way?thanks for starting the series and spreading financial awareness among all communities. Best of luck.

    1. Thank you. I am blessed with intelligent readers who manage to understand what I am trying to convey 🙂

  3. Thanks Pattu sir. We are eagerly waiting for this. As the old guide seems little outdated due to change in the VR site. Also when you write, can you throw more light on debt mutual funds and how to select them ? Like Bond funds, MIP, FMP, etc as well ?
    Thanks
    Adai

  4. Dear Sir,
    When i read for the first time about what to expect , 10 or 12 % sounded too low and unexciting for a layman like me. Then i understood the power of compounding and tried telling myself like this. if i stay invested for 12 years and a CAGR of 12 % that makes the money 4 times which is not bad. Too many valuable lessons from your site and now a revison of what we have already learnt. Don’t know how to Thank You Sir..

  5. Hello Sir, please clarify on… This is crucial because many people make the mistake of investing in 100% equity for long-term goals

    Is being in 100%equity MF (sbi blue chip) wrong ? I do have FDs and ppf.

  6. Hi Pattu ,

    I do have the same query regarding the 100% equity selection. I have substantial FD in my overall portfolio. ( I can say even overweight FD in my whole portfolio).

    In this case, i have decided to build my all goal related portfolios only with 100% equity funds.

    Should i worry about the below point , which you mentioned in this article :

    “This is crucial because many people make the mistake of investing in 100% equity for long-term goals. “

    1. I don’t think any goal should have 100% portfolio exposure.

Leave a Reply

Your email address will not be published. Required fields are marked *