Choosing a Mutual Fund

Choosing the right funds—and trusting your decisions enough to back them with your money—is challenging. To keep from getting overwhelmed, be sure you understand what you want for your money (protection, income, growth), then look only at the funds that aim for the same thing. But where can you look for information?

Look at the fund prospectus
The prospectus is essentially the user's manual for a mutual fund. It has the reputation of being dense and complicated to read, but recent changes in regulations have required funds to make every prospectus much simpler, especially in the key areas of understanding performance and expenses. Simply looking at the charts and tables in the first few pages will tell you a lot you need to know.

What's in a prospectus? The SEBI requires every fund to publish a prospectus and update it annually. It covers all of the important elements, such as the history, management, financial condition, performance, expenses, goals, strategies, types of allowable investments, and policies.




Performance: Each fund must tell you how much it has increased or decreased in value in each of the past 10 years (or for every year of its existence, if shorter). This is labeled in the prospectus as "performance" or as "annual total return." Fund performance is required to be shown against a relevant industry benchmark, a performance measure used by the industry of how the market segment has performed as a whole compared to the investments in that segment held by the fund. Typically, the benchmark will be an "index" for that category.

Average annual return: While every fund has to show its annual performance, every fund also must to tell you its average return on a yearly basis. Average annual return is important because it keeps funds from promoting their best years and ignoring their worst years. It takes the total returns for each year and averages them across the number of years the fund has been in existence.

Fees and expenses: The prospectus will tell you if a fund charges a sales charge or is a "no-load" fund, meaning that there is no up-front sales charge. All funds charge management fees and expenses, which will be described in the prospectus.

Use independent rating services
Independent rating services: often provide a convenient way to find out information about a fund very quickly. These services typically provide you with a rating or ranking of a fund based on its performance relative to its broader peer group, as well an opinion about a fund's management team and operations. When you subscribe to a service, you may get access to a wide range of information and services, depending on your subscription level. Tools and resources typically include access to fund ratings or rankings, computer-based guides, educational materials, and monthly and quarterly newsletters.

Risks
Because mutual funds typically hold a large number of securities, their level of diversification provides them with a lower level of risk than investing in a single stock or bond.

However, investing in mutual funds still contains a number of risks that you should consider before investing, including:

You could lose money, Your money may lose buying power, You may not achieve your goal, Your investment may rise and fall in value Other risks You could lose money

Every mutual fund prospectus will highlight this point. It's the most obvious and feared risk of investing. There are, however, many strategies for managing this risk, particularly over the long term.




Your money may lose buying power
This risk is also known as inflation risk: as prices increase, your investments must increase in value at least at the same pace, or you'll lose purchasing power.

You may not achieve your goal:
Probably the biggest, yet most overlooked risk of investing, is the risk of not achieving your goal. It's probably overlooked so often because so few investors actually set goals, and many others set unrealistic goals. Furthermore, many investors don't buy the right investments to help them achieve their goals. This type of risk is often called shortfall risk (falling short of your goal). For example, if you are investing to pay for a future college education, a money market fund might feel safe. But it's highly unlikely that you'll reach your goal.

Your investment may rise and fall in value : Almost all investments have the potential to gain and lose value. This is known as market risk. In other words, the price of any investment, whether it's stocks, bonds, mutual funds, or any other, is likely to rise and fall over time. Seasoned investors tend to ignore the relatively small price movements in their investments, preferring to try and capture the more significant fluctuations they can better anticipate. If you invest for longer periods of time, market risk may become less dangerous to you. That's because, over the long-term, most investments tend to rise in price. Market risk, however, can place investors at a significant disadvantage if they are forced to sell at a time when prices happen to be down.

Foreign exchange or currency risk:
If you invest overseas, the exchange rate between your home currency and the foreign currency adds an extra layer of risk to your investment. The stock or bond you buy may go up, but the exchange rate may go down so far that it wipes out your gain.

The halo effect : When something wonderful happens to one stock in an industry, many of the others in that industry may also enjoy a rise. This is known as the Halo Effect. But it also occurs in reverse, taking value out of perfectly good investments just because they are linked in the minds of investors to another investment that is experiencing a problem.