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6 Questions You Need To Ask Before Investing In A Mutual Fund

6 Questions You Need To Ask Before Investing In A Mutual Fund
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Mutual fund investments are widely considered a necessary tool for building a well-rounded investment portfolio. However, just like the broader financial services market, there is no one-size-fits-all mutual fund product. Therefore, you need to ask the right questions to determine what works best for your needs. Think of the MF market like a dinner buffet, with offerings ranging from highly safe debt funds to highly risk-oriented funds and everything in between. If your goal is to eat healthy, you would go for the salads, right? And if you're okay with a few extra calories, you'd make a beeline for the gulab jamun. Similarly, once you know what the different kinds of mutual funds are like in terms of their features, risk profiles, and benefits, you'll have a better idea of how they fit your specific requirements.

Hence, here are some questions you should ask your mutual fund distributor/financial advisor.

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What is the fund's objective?

Each mutual fund is set up with a certain objective in mind. It could be to focus on a particular market (such as equity or debt), a sector (such as banking or real estate), a basket of stocks across sectors, a certain geography (emerging or developed markets), or even in other funds (fund of funds). This guiding objective will influence how the fund house spends, manages and grows its investors' money.

Asking about the fund objective or theme helps you understand how and where your money is going to be allocated..

How has it performed against the benchmark index?

In school, we all knew that Guptaji ka beta or Sharmaji ki beti, whose scores were the benchmark against which our own report cards were judged. Well, whether or not that was right, there is a similar example in mutual funds. Each fund is typically benchmarked to a market index, such as the BSE Sensex, NIFTY 50, S&P CNX 500, etc. In the long term, if a fund does better than its benchmark index, that's good news. If it delivers the same or lower returns than the benchmark, it is not-so-good news.

Knowing the one, three, five and ten-year returns against the benchmark will help you take a decision on whether the fund is worth investing in. However, one must also keep in mind that past performance is never an indicator of future returns.

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How has it performed against similar mutual fund schemes?

The other benchmark to gauge the fund's performance is similar mutual funds by other fund houses, whose investment focus is the same as the one being considered. Doing this will give you a clearer idea of whether the fund has delivered results to investors.

What type of fund is it?

There are different types of funds out there, and understanding how exactly they will allocate your money is important. Equity-focused funds invest in stocks of various companies. Similarly, debt-focused mutual funds invest in bonds and other securities. Balanced funds invest in a mix of equity and debt, while a gold exchange-traded fund may do none of the above and invest instead in gold bullion. Therefore, make sure you ask this important question.

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How will this fund help me achieve my goals?

Each individual has short and long-term goals. Do ask the distributor/advisor how his/her recommended fund will help you achieve your goals. For example, buying a car in three years and arranging for the marriage of your children after 20 years require very different kinds of investment approaches. So lay out your goals and be firm about choosing a scheme whose tenure, investment focus and risk profile is likely to help you achieve those goals.

Are there any tax benefits?

Equity Linked Savings Schemes and various pension fund schemes provide tax benefits under the Income Tax Act. Investing in these funds can give you the dual advantage of equity exposure and tax planning. If tax saving is one of your objectives, be sure to ask the distributor/advisor about the tax benefits of the fund.

We hope this guide helped you figure out the right questions to ask before choosing a mutual fund. Mutual funds as an investment avenue have been gaining in popularity over the years, thanks to the wide range of options available and the convenience they offer. To know more about them, check out The Mutual Funds Sahi Hai campaign, launched by The Association of Mutual Funds in India (AMFI),at www.mutualfundssahihai.com.

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This article exists as part of the online archive for HuffPost India, which closed in 2020. Some features are no longer enabled. If you have questions or concerns about this article, please contact indiasupport@huffpost.com.