Factors Affecting Mutual Fund Investment Decisions
12 July, 2024
Synopsis
Key factors influencing mutual fund performance include market fluctuations, liquidity, credit risk, interest rate, and inflation.
Investors should choose funds that are aligned with their investment objectives, risk appetite and investment horizon. It is also important to analyse fund's historical performance.
The HDFC Bank SmartWealth App helps investors in making informed decisions by mapping investments with the financial objectives and risk profile of the investors.
Mutual Funds are not much different from cricket; it is for those who can understand the various factors that influence the game. Successful players go on to play long innings, and it is only after playing in the long term that cricketers leave their mark on the game and achieve their targets.
Similarly, in the case of mutual funds, an investor must play a long, patient innings and have the strength to withstand the vagaries of the markets. This is only possible when an investor is aware of the factors that influence the game of mutual funds before they start playing it.
Like a batsman, an investor should be able to choose the right ball to play, leave or duck. In cricket, a batsman gets a variety of balls from the bowler. Similarly, an investor is bombarded with different schemes from fund houses in mutual funds. Just as it’s not easy for batsperson to pick the right ball to hit a six, it’s not easy for an investor to choose the right scheme to invest in. It is risky to choose the wrong ball to hit a six. And investing hard-earned money in a wrong scheme could prove to be disastrous.
As in cricket, the thumb rule is knowing the key factors affecting your investments. Understanding these nuances will help you make long investment innings with ease and investment decisions aligned with your financial objectives and risk appetite.
Let us try to decode the major factors that can influence mutual fund investments.
Factors Affecting investment in mutual funds
Every investment comes with a certain degree of risk. Equity funds tend to be more volatile, given their exposure to stock markets. Debt funds are relatively less risky but still not completely risk-free. Some risks that can impact mutual fund investments are: are relatively less risky but still not completely risk-free. Some risks that can impact mutual fund investments are:
Market Risk: Risk of loss due to factors affecting the overall performance of financial markets.
Liquidity Risk: Investment may become illiquid due to lack of buyers.
Credit Risk: Risk of default in debt funds if the issuer fails to repay.
Interest Rate Risk: Risk of bond prices falling with a rise in interest rates.
Inflation Risk: Risk of inflation outpacing your investment returns.
Being aware of the risks can help you make sensible fund choices that align with your risk appetite. For instance, equity funds are best suited for investors with a high-risk tolerance and long tenure.
Understand Your Investment Objectives
The first and foremost factor is clarity about what you wish to achieve from your investment. Do you want to fund a world tour, start a business, a farm house in picturesque hills to spend your golden years, buy a dream car, create an emergency fund, or renovate your home? Your investment dreams will steer your decisions.
For instance, if you are investing for long-term retirement objectives, you may want to allocate a larger portion to equity funds, which can deliver inflation-beating returns over the years. On the other hand, debt funds are a safer bet if you need funds for short-term investment objectives like an overseas vacation.
Evaluate Your Investment Appetite
Every investment carries some degree of risk. How much risk are you comfortable taking? Can you endure volatility and temporary losses for potentially higher returns? Or would you prefer lower but steady returns?
Your risk tolerance depends on factors like your age, income stability, dependents and more. Typically, younger investors have a higher capacity to take risks. As you near important objectives, your risk appetite reduces. Analysing your investment profile will guide you in the appropriate asset allocation of equity, debt and hybrid funds.
Consider Investment Horizon
Your investment horizon refers to the period for which you plan to stay invested. The longer your investment horizon, the more risk you can potentially take.
For financial objectives more than 10 years away, equity-oriented funds make more sense. As the horizon reduces, you can allocate more to debt and balanced funds to protect your capital. Aligning your mutual fund choices with the investment horizon is key for optimal asset allocation.
Evaluate Historical Performance
While past performance does not guarantee future returns, long-term historical track record gives insight into a fund's consistency. Opt for funds that have performed well across market cycles and generated healthy returns above their benchmark index and category average.
However, don't just chase last year's best-performing fund. Instead, assess the performance over 3-5-year periods for a realistic picture.
Consider the Costs
Mutual funds come with recurring expenses like fund management fees and operational costs. Although this expense ratio is capped as per a fund’s AUM size, a lower figure is better. Higher costs can potentially eat into your returns in the long run.
Evaluate the Total Expense Ratio (TER) while selecting a scheme. Index funds and ETFs generally have low TERs. Also, beware of funds charging excessive exit loads if you intend to redeem your fund in the short term.
Ensure Portfolio Diversification
While mutual funds provide diversification, investing in too many similar funds can lead to over-diversification. For instance, two large-cap equity funds may have overlapping holdings, giving less or no advantage of diversification.
Analyse your overall portfolio allocation to ensure optimal diversification across market caps, sectors, fund houses and fund managers. Avoid concentration risk by capping investments in a single fund or sector.
Stay Invested for Long Term
Historically, equity investments have delivered the best long-term results despite short-term volatility. Resist the urge to frequently shuffle your portfolio based on market sentiments.
Give your fund investments time to ride out market ups and downs. Exercise patience and continue investing through SIPs to benefit from rupee cost averaging and the power of compounding.
Evaluating key parameters like financial dreams, risk appetite, time horizon and portfolio diversification is crucial before investing your hard-earned money into mutual funds. Stay patient, invest regularly, minimise costs and take a long-term view. With prudent decision-making, mutual funds can help you achieve your financial aspirations.
If you are still nervous about making the right investments in mutual funds, just download the expert-curated HDFC Bank SmartWealth App. This DIY app helps you make the right investments based on your investment profile and financial objectives, and that too after considering in the factors that can influence mutual fund investments.
Disclaimer: This communication has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. HDFC Bank Limited ("HDFC Bank") does not warrant its completeness and accuracy. This information is not intended as an offer or solicitation for the purchase or sale of any financial instrument / units of Mutual Fund. Recipients of this information should rely on their own investigations and take their own professional advice. Neither HDFC Bank nor any of its employees shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in this material. HDFC Bank and its affiliates, officers, directors, key managerial persons and employees, including persons involved in the preparation or issuance of this material may, from time to time, have investments / positions in Mutual Funds / schemes referred in the document. HDFC Bank may at any time solicit or provide commercial banking, credit or other services to the Mutual Funds / AMCs referred to herein.
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