Step-by-Step Guide to Choosing a Mutual Fund

Published: December 21, 2012 at 12:56 pm

Last Updated on

Download a free PDF Step-by-Step Guide to Choosing a Mutual Fund. You can use this to confidently invest in mutual funds on your own!


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Do let me know if found this useful or if you use a different method/criteria to choose your funds.

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Join our 1500+ Facebook Group on Portfolio Management! Losing sleep over the market crash? Don't! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free! Did you miss out on the lockdown discount? You can still avail it! Follow instructions in the above link!

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Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com

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  1. This is extremely good sir! I am sending this link to all my friends! Thanks Sir 🙂
    Can you add your blog name in all pages? so that ppl know where its downloaded from?

  2. Thanks a lot for creating excellent calculators. Great for financially challenged people like me. Great job ! I am a subscriber now.
    Vijay Sethi

  3. Sir there is a humble request, as i am new to this MF environment . I have money invested in PPF ,LIC and some in FD but i am looking to diversify my portfolio byjumping into MF’s. I picked out ICICI Prudential blue chip equity fund. And i came across this wonderful online facility “FUNDSINDIA” as a medium to invest in MF, they said it is absolutely safe to invest with them. As as novice investor i am worried about it. Can u help me out.

    1. If you are asking me if FundsIndia is safe to invest, then yes it is. Please go ahead. They have some ready made portfolios. Once you are comfortable with the ICICI bluechip fund you can consider using these portfolios according to your goals and risk appetite.

  4. Could you please reupload the pdf file? The file is damaged and cannot be opened. Thankyou!

  5. Hi Pattu,
    Short & Long term capital Tax liability arises out of investments into Equity and Debt MFs, stocks. These calculation and filling ITR2 is complicated for majority of people. Can you help by providing full guide with calculators please?

  6. I’d like to add something to your presentation: continuity of fund manager, and portfolio churn / turnover. It is generally better to go for a fund with lower turnover, all things equal, and continuity of fund manager is a plus. Moreover, the fund manager should not be managing too many schemes.

    1. Hi, both the points you have are pertinent.
      Investing in a fund with a low churning is important for long term growth. No doubt there. I will include this when I make a second version. That said it may or may not reflect good performance. FI Blue chip has a churn over of 69% which is pretty high for a blue chip. Birla Frontline equity has a ratio of 160%!! A fund which adapts itself continuously to changing market conditions and staying well above benchmark is also good to have in a portfolio.

      Continuity of fund manager is an issue I would like to worry about after I invest and not before. Many funds like FI Blue Chip have performed regardless of change in fund manager. A strong fund house with a clear strategy is more important than individuals.

      1. Yes, if readers are looking at the strategy and deciding that it has not changed recently, then fund manager continuity is not an issue. It has to be a strategy that does not rely on individual style (DSP top 100 relies heavily on the individual ability of Apoorva Shah).

        Another point is to look at the portfolio. Some small / mid-cap funds are closet large-cappers. I believe the greatest distorting factor of Indian funds is the consumer demand for portfolio management at the fund level. A fund is an individual investment, and it should take a ‘pure’ strategy, asset class & style. The manager should stick to this mandate through thick & thin. I like to see a portfolio that is supposed to invest 100% in equity stay invested in equity even through the worst recession or crisis (as opposed to sitting on cash). Similarly, a small/mid cap manager should not stray into large-caps. I, as portfolio manager investing in various funds & rebalancing, will take care of diversification & minimizing volatility. Fund managers have no business moving between asset classes or strategies.

        AUM size is also another variable for small & midcaps. If your 7 year return is based on small AUM, and it has attracted several times the AUM now, it is not guaranteed that you can continue your performance. Again, looking at the portfolio will detect whether the manager has been able to find liquid scrips in that space. Morningstar gives a good portfolio breakup by large / mid / small, debt,, cash etc.

        1. Thanks. These are very important points. Trouble is, fund manager action is part of a vicious circle. Investors want returns, fund house want investors and fund managers want to keep the job by beating benchmarks. The best way out of this confusion is to switch to passive funds and live with zero alpha.

          1. Yes, and the benchmarks they show themselves beating are not usually the total return variants of the underlying index, nor always the appropriate index. For example, every bluechip should be able to beat CNX 100 total return (dividend reinvested) as opposed to Nifty (capital gains only), because that is the risk-equivalent alternative for investors confine themselves to top 100 stocks of the economy. I rarely see MFs comparing themselves to this. Why should they? It comes only with investor demand.

            in the long run, I am optimistic that Indian investors will become financially aware and savvy. This should lead to better accountability of MFs, as well as good indexing and ETF options. (For example, a equal weight CNX midcap index fund with low exp ratio would be very nice). However, since the long-run will come with my grey hairs, I confess that I have already adopted a passive approach, constructed my own home-made index (annually rebalanced because life is too short to fuss over small tracking errors) and diversified away from India (not too hard to open a good foreign brokerage with discount fees).

            A portfolio built faithfully around imperfectly correlated assets, diversified across countries and currencies, minimizing tax and fees, rebalanced as much as tax considerations allow, will generate such good returns over 10yr+ horizons that you will not regret giving up some domestic alpha 🙂 Having said that, you can indeed generate alpha over Nifty. Equal weighting, value tilting, small/mid tilting will introduce these extra returns.even on a risk adjusted basis as far as past returns show. In fact, it can be done quite easily over the long-term with the CNX 500, which is large-cap oriented but offers some return upside of the remaining economy.

          2. Fantastic points. Could not agree more. Good feeder funds like FT Feeder US and FT Asia should give international exposure to even those who cant or wont pick stocks.

          3. found very interesting and insightful reading on equity (mf) investments on your discussion with abvblogger , though frankly do not understand much about the self made index investment. thank you both of you.

          4. Dear Bharat Shah, it is my pleasure and I have learned a lot from the writings of bloggers such as Mr. Pattu. By self-made index, I mean a crude approximation that I make myself, of CNX Midcap & CNX Smallcap, purely because I find the ETFs and index funds on offer inadequate. I equal weight CNX Midcap & CNX Smallcap, and buy when the valuation (Price-book or price-earnings ratio or dividend yield) is attractive. Equal weight means 100 scrips get 1% each in the portfolio. It is not very hard – a good discount broker like zerodha charges no more than 20 rupees per trade, and they allow you to save a ‘basket’ order in excel and upload it into their system. So a couple of hours work the first time to create LIMIT orders, and from then on, you just keep submitting the excel. But I only rebalance to equal weight annually, to benefit from tax & reinvest the dividends. The major disadvantage of a homemade ETF is tracking error; ideally one should rebalance continuously, every day even. But this will involve brokerage, taxes etc. and also time. I embrace my tracking error as I prefer this to giving 1 to 1.5% every year to a mutual fund that in all probability will not match the total return of the index over long horizons like 10+ years.

            @mr. pattu: I would beware of feeder funds. I fear these are opportunistic products and the investor has a far better alternative. Just last night I bought VTI (vanguard total stock market) etf through interactive brokers from the comfort of my home in Chennai. You need a minimum amount to open a brokerage account with them, but if you do, it’s quite easy to trade on the exchanges. I pay a flat rate of 1$ per trade but you can opt for a cost+ brokerage plan that may be better. VTI purchases 3300 stocks in the US market, replicating the total market, with a total annual expense ratio of 0.05%. So my total cost of holding is 0.4% for brokerage (it goes down if you invest more in a trade) and 0.05% expense ratio – compare that with a feeder fund that charges upto 2% or more annually and will in all probability will not beat the index. One perceptual bias in the Indian market is the alpha we take for granted; the US is a different market where the probability of a fund manager beating the market over any horizon is much, much lower. I fear that these feeder funds are taking advantage of this perceptual bias and the inherent difference in probabilities, and I wish they had been honest enough to collect less fees and just index. They could have still made a healthy 1% fees and it would have been fair. But to feed their own fund in the US, and double charge active fees…

          5. Thanks for the detailed response. What you say does make a lot of sense. How are the gains from such investments taxed? The same as the feeder fund?

          6. Ah here we enter a point of real uncertainty. I believe the taxation in India is exactly the same as feeder fund i.e. it is treated as a debt product. As far as I have researched, the US at its end will not tax because it has a tax treaty with India – you have to mention your Indian residency to them & submit a form which the brokerage will provide. Having said all this, three caveats: 1. I invest through my father’s account and he is an NRI 2. We have not yet filed returns for these investments because a) NRIs don’t pay tax on overseas investments b) we have just started investing, so it only applies in the case of redemption 3. I would not put it past RBI to change the tax laws to punish investing abroad, because there is serious retail investor interest looming on the horizon and that’s a capital outflow. They have already decreased the amount one can invest in a year. Is diversification worth the tax headache and uncertainty? I think yes, because it is partially offset by exchange rate gains and partially by the reduction in risk. Only time will tell.

          7. @abvblogger, thank you very much for your process outlining the self made index formation including balancing and how to implement with help of discount broker in detail. also you very well narrated the alternative of feeder funds. better you mention some interactive broker for information.i think the investment may be limited under RBI exchange rules without need of seeking individual permission for such investment. i just guess that the profit from such investment may be taxed at highest i.t. rate , and not as reduced rate at debt mf.
            @pattu i think , the alternative to traditional mutual funds could be a investment company , investing in equity shares of indian moat companies for long period as Warren Buffet’s .

  7. I recently read about Sortino ratio and Treynor ratio. Does it add value to the selection process ? If you want to update the blog on those lines and also on Fund Manager along with AuM size that would be really great. How i wish we could all that info at one place ?
    Does anyone know where it is available readily ? Cheers

    1. Hi Vinay, Yes they do, but it is more suitable for advanced users. For the beginner, standard deviation and beta is more crucial than alpha. You get all risk parameters at MorningStar.

      As for size, the long term investor does not worry about size as long as the fund manager has a sound strategy. A small size allows quick movement in and out of stocks. However, that does not guarantee returns. I think a fund with lower volatility is more important than a fund with small size and high turnover ratio.

  8. Thank you for the clarification. Now i am gonna follow morningstar. Being new this site of yours is like ‘Engineering in Personal Finance Planning’ if not diploma. Keep up the good work mate.

  9. Thank you for this insight on selection for beginners. I am looking as making selection by myself going forward and this guide of yours is very helpful. I have been investing for the past 3 to 4 years now, and would like to review my existing funds. A simple guide on periodic review of performance will be really helpful for many of us.

  10. Thank you for the pointers, and yes, I am refering your works to my friends as this is really a useful resource in learning to manage ones finances.

  11. Dear Sir

    Many thanks for such a wonderful site. It’s extremely useful.

    Went thru the pdf file to select a fund. However, when I check the value of various parameters (e.g. Beta, SD, R-Sqaure, Sharpe Ratio) on ValueResearch, there is a difference between values indicated on ValueResearch and the fact sheet of the scheme. For example: as per Feb-2014 Factsheet for ICICI Prudential Discovery fund: SD: 17.71%, Sharpe Ratio: 0.17, Beta: 0.77, R-Squared: 0.88 and as per ValueResearch website: 18.31, Sharpe Ratio: 0.38, Beta: 0.91, R-Squared: 0.75. Not sure when the difference is small enough to be ignored? May be the difference is due to the fact that ICICI Factsheet is calculating these quantitative measure based on last 3 years while ValueResearch may be longer than that? What is your view on this?

    What is the meaning of a SD of 4.53? The Feb 2014 Factsheet of Franklin India Bluechip Fund the fund has SD of 4.53. How to interpret this?

    Appreciate your reply.

    Thanks again for the excellent articles on this blog.


    1. Hi Vikas, Thank you. These ratios depend on the duration chosen.If I am not wrong the VR duration is at least 3 years. I suggest you use morning star for these parameters. The duration will be clearly mentioned.
      SD the standard deviation should always be interpreted with the average return.

      If avg return is 10% and SD is 5% for a period of 5Y, say. About 68% of times in this duration, returns have fluctuated bet 10-5 =5% to 10+5 =15%
      So lower the SD, lower the volatility.
      Let me know if you need further clarifications.

  12. Sir, a small question. Why did you not choose “SBI Magnum Equity”/ICICI_Top_200 in your sample selection for Equity:Large-Cap analysis? My question is why not the analysis is not done on first four ranks instead of 1,2,4,6 ranks? you choosed these after all the top 10 analysis and then continued with example?

    1. Once you single out consistent performers, there is little point trying to choose one among them. You can make your own shortlist and then proceed further.

  13. Dear Sir,
    Can you please send the PDF file “step-by-step guide to choose a mutual fund”? I am not able to find/download PDF file?

  14. Dear Sir,
    Can we use same selection method for Debt funds as well? if not then I will select the debt funds?

  15. Hello Sir

    Today i was reading your PDF regarding searching of MF via Value research but couldn’t find the risk & Volatility link in valueresearch website. Sir, can i get these details from any other website if Valueresearch has stopped it.

  16. Hello,

    VRO look and content is different than what is provided in the pdf. Are there any plans to update the book to batch VRO?

    thank you!

Comments are closed.