How To Pick A Good Mutual Fund and My Way of Buying funds...

Are you thinking about investing in a mutual fund, but aren't sure how to go about it or which one is the most appropriate based on your needs? You're not alone. However, what you may not know is that the selection process is much easier than you think.

Identifying Goals and Risk Tolerance

Before acquiring Units in any fund, You must first identify his or her goals and desires for the money being invested. Are long-term capital gains desired, or is a current income preferred? Will the money be used to pay for college expenses, or to supplement a retirement that is decades away? Identifying a goal is important because it will enable you to dramatically whittle down the list of the more than 5,000 mutual funds in the public domain.

In addition, You must also consider the issue of risk tolerance. are you able to afford and mentally accept dramatic swings in portfolio value? Or, is a more conservative investment warranted? Identifying risk tolerance is as important as identifying a goal. After all, what good is an investment if the you has trouble sleeping at night?

Finally, the issue of time horizon must be addressed. you must think about how long you can afford to tie up their money, or if they anticipate any liquidity concerns in the near future. This is because mutual funds have exit charges and that can take a big bite out of your return over short periods of time. Ideally, mutual fund holders should have an investment horizon with at least five years or more.

Style and Fund Type 
If you intends to use the money in the fund for a longer-term need and is willing to assume a fair amount of risk and volatility, then the style or objective he or she may be suited for is a long-term capital appreciation fund. These types of funds typically hold a high percentage of their assets in common stocks and are, therefore, considered to be volatile in nature. They also carry the potential for a large reward over time.

Conversely, if you are in need of current income, he or she should acquire Units in an income fund/MIP'S. Government and corporate debt are the two of the more common holdings in an income fund.

Of course, there are times when you has a longer-term need, but is unwilling or unable to assume substantial risk. In this case, a balanced fund, which invests in both stocks and bonds, may be the best alternative.

Evaluating Managers and Past Results

As with all investments, you should research a fund's past results. To that end, the following is a list of questions that perspective investors should ask themselves when reviewing the historical record:

• Did the fund manager deliver results that were consistent with general market returns?
• Was the fund more volatile than the big indexes (meaning did its returns vary dramatically throughout the year)?
• Was there an unusually high turnover (which can result in larger expense ratio for you)?

This information is important because it will give you insight into how the portfolio manager performs under certain conditions, as well as what historically has been the trend in terms of turnover and return.

With that in mind, past performance is no guarantee of future results. For this reason, prior to buying into a fund, it makes sense to review the investment company's literature fact sheet to look for information about anticipated trends in the market in the years ahead. In most cases, a candid fund manager will give you some sense of the prospects for the fund and/or its holdings in the year(s) ahead as well as discuss general industry trends that may be helpful.

Adding to this let me Share how I select Mutual Fund scheme by studying technical data by giving you example.

first i see what is Alpha of mutual Fund Scheme ? 

Alpha talks about risk adjusted performance - whether a scheme has performed as expected or not. 

Then why shouldn't I just look at annualized return instead?

By looking at return (CAGR) only, i can't have an idea what risk it took to generate such return. So if Fund A and Fund B has generated same return, but if Fund A has taken more risk, then its Alpha would be lower than Fund B. Alpha is also sometime known as "fund manager's contribution" in return. As far as risk taken by a fund, it is expected to generate a certain minimum return. If it surpasses that expectation then we say it has created positive Alpha.

So, if I found a scheme's Alpha is 10, what does that mean?

It means whatever return was expected from this scheme, it has outperformed that by 10%. Alpha can be negative, zero or positive. But remember zero Alpha does not mean zero return. Zero Alpha means return as per expectations, neither outperformed nor under-performed. 

But how do I come to know what return is expected?

For that i need to check its Beta. 

Beta?

Yes, Beta denotes the risk. Suppose the scheme's Beta is 1.2. This means if its benchmark index moves upwards by 10%, scheme is expected to move upward by 12%. Alternatively if benchmark index moves downwards by 10%, scheme is expected also to move downward by 12%. If a scheme's Beta is 1, the scheme is expected to generate as much return as its benchmark index.

So should I check Alpha or Beta then?

Both. Say, i want less risky Fund. So i should first make a list of all the funds which are having low Beta. Then within that list look for high Alpha.

So suppose a scheme's benchmark index moves upwards by 10%, its Beta is 1.2 and its Alpha is 8 does it mean then that the fund was expected to generate a return of 12% as per its risk exposure but the fund even outperformed that expectation by generating a return 20% (12 + 8).

Brilliant!

So Beta has lot to do with a fund's benchmark index. But not all funds' portfolio has same level of similarity with its benchmark index's portfolio. In that case can its Beta be accurately calculated?

Oh yes! Sometime some fund's portfolio has hardly any similarity with its benchmark index's portfolio. In that case its Beta cannot be trusted much.

How to be sure then whether we can depend on Beta of a fund?

Check the value of its R-Squared. If it is between 75 to 100 - it means fund's portfolio has lot of similarity with its benchmark index's portfolio and hence its Beta can also be correctly derived.

So a Index Fund's R-Squared would be 100?

Brilliant! Yes, it should be. If not 100, at least close to 100. 

So "high R-Squared - low Beta - high Alpha" is a great combination then?

Yes, i can say so. But remember low Beta is not always good. my portfolio should have all type of funds. In bullish time, high Beta funds are great to have. Whereas during bearish time, low Beta funds are in high demand.

for your reference attached Scheme selected data.

		ALPHA	BETA	R-SEQUARE
FRANKLIN india Prima Fund - Growth		14.19	0.78	87.48
ICICI pru value discovery fund -growth		11.55	0.8	87.6
birla sunlife frontline equity fund		6.67	0.99	97.34
KOTAK 50 equity - growth		3.72	0.99	91.11
DSP BR TOP 100 FUND GROWTH		-0.47	1.06	91.88
RELIANCE GROWTH FUND GROWTH		4.29	1.1	84.86
HDFC EQUITY FUND GROWTH		2.74	1.2	85.76

The Bottom Line

Selecting a mutual fund may seem like a daunting task, but knowing your objectives and risk tolerance is half of the battle. If you follow this bit of due diligence before selecting a fund, you will increase your chances of success.