Mutual fund investment: How to choose the right scheme from a multitude of options? An expert explains the method..

Mutual Fund Investment: Mutual funds have become the preferred choice for growing savings and building long-term wealth. However, when a new investor enters the market, the biggest question they face is where to begin. There are hundreds of schemes available—such as large-cap, flexi-cap, mid-cap, small-cap, hybrid, and debt funds—each with its own risk profile, return potential, and time horizon. Consequently, many new investors opt for an easy shortcut: they simply look for the fund that has delivered the highest recent returns and invest in it. Experts warn that this approach can lead to significant losses.

How do you choose the right scheme?
Rishabh Garg, CEO of FundsIndia.com, explains that looking solely at past performance is insufficient when selecting a mutual fund. Whether a fund is right for you depends on your financial goals and your capacity to withstand losses during a market downturn. According to Garg, new investors should consider three fundamental factors before evaluating any specific fund.

The first factor is your financial goal and the time horizon associated with it. For instance, money set aside for a vacation in two years should never be invested in a fund intended for retirement planning twenty years down the line; the strategies for these two goals are entirely different.

The second crucial factor is your actual capacity to bear losses. Garg emphasizes that investors should not assess risk merely in abstract terms. They need to honestly consider how they would actually react if their portfolio were to drop by 20 to 25 percent during a market slump. If an investor panics and exits a scheme at the first sign of a major market downturn, then that fund was not the right choice for them—regardless of how impressive its past returns might have been.

The third aspect relates to the fund itself, encompassing its category, track record across various market cycles, and expense ratio. These factors should be considered only after defining one's goals and risk appetite.

**Choosing a scheme based solely on past returns is a mistake**
New investors often gravitate toward funds that appear at the top of performance charts. Rishabh Garg cautions that while past returns are certainly useful, they should not be the sole basis for making a decision. A fund topping the one-year return charts might have surged simply because a specific segment of the market was rallying during that period; such funds often see their performance shift as market conditions change.

Therefore, instead of looking at just one year's data, investors should examine performance over 3, 5, and—if available—10 years. It is also crucial to assess how well the fund held up during market downturns and how it performed relative to its peers. Garg notes that a scheme delivering consistent, stable returns is preferable to one that swings between exceptionally high and poor returns.

**Select the right category based on your goals**
Investors should plan by working backward from their goals. If funds are required within one or two years, debt funds are a better choice. Hybrid funds are suitable for goals a few years down the line, whereas equity funds are considered ideal for goals with a horizon of five years or more.

Within the equity category, large-cap and flexi-cap funds can form the core of a new investor's portfolio. While mid-cap and small-cap funds offer significant growth potential, they are also subject to high volatility. Therefore, new investors should avoid allocating a large portion of their capital to these initially.

**Choosing schemes based on time horizon**

**3-year goal:** If you need to make a down payment for a house in three years, the priority should be capital preservation. For this, one should focus on debt or short-duration funds, with perhaps a very small allocation to hybrid funds.

**5-year goal:** If funds are required for a child's school admission in five years, a balance between growth and stability is needed. In this case, one could opt for hybrid or flexi-cap funds alongside debt funds. As the goal approaches, the money should be gradually shifted into debt instruments.

**10-year goal:** For long-term goals like retirement (spanning 10 years or more), a significant portion can be allocated to equity, as the long timeframe provides ample opportunity to recover from market downturns.

**A simple formula for choosing mutual funds**

To avoid getting overwhelmed by the multitude of available schemes, you can adopt the straightforward 'Goal, Category, Check' formula. You can then select one or two suitable schemes based on your preference.

The first step is the **'Goal'**—determining exactly how much money you need and when you need it.

The second step is **'Category'**—selecting the right category based on your time horizon and risk appetite. This narrows down the list of hundreds of options to just a few relevant funds.

The third step is the **'Check'**—comparing 3 to 4 funds within that category based on their long-term performance, expense ratios, and the strength of the fund house.

For a new investor, starting with a single, well-diversified scheme is far more effective than purchasing five different schemes simultaneously.

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