There are thousands of mutual funds available on the market today. That means you need a good understanding of your financial goals to choose the right mutual fund for your needs.
Are you investing for retirement in your 401(k) account? Which is more important, long-term capital gains or recurring income today? Answering questions like these about your financial goals are essential before you begin diving into the world of the best mutual funds.
After you’ve determined clear goals, you should also understand your risk tolerance. Are you willing to see big swings in the value of your mutual fund over the short term in exchange for better gains over the longer term? Would you be more comfortable with a steady, gradual rate of appreciation plus reliable income payments?
You may already understand that risk and return are directly proportional. That makes it essential to calibrate the rate of return you expect against the amount of volatility you can accept in your mutual fund investments.
Once you’ve settled on a level of risk that’s right for you, you’ll need to start digging into mutual fund lists like this one and start researching individual funds. Learning about how each fund works helps you know if it’s right for your goals and risk tolerance.
Learn about each fund’s management team. Do they have a history of success? For active funds like we have listed above, it’s important to read the managers’ track record.
Does a fund have a high or low turnover rate in its investments? When fund managers buy and sell frequently, it creates taxable events. That’s nothing to worry about if you own shares of a mutual fund in a tax-advantaged retirement account, but if you own shares in your taxable brokerage account, that could greatly diminish your long-term gains.
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There are various types of mutual funds. We can segregate mutual funds based on their underlying assets such as equity, debt or gold into different categories, such as equity mutual funds, debt mutual funds and hybrid funds. These funds have different risk profiles and investment objectives.
So, there is not one mutual fund that is best for everyone. The best mutual fund for you will be the mutual fund/s suitable for your investment objectives, risk tolerance, and investment horizon.
For example, let us assume you are building an investment corpus for your child’s higher education after 15 years. It is this case, as you are investing for the long term, equity mutual funds can be the best option for you. However, there are other sub-categories within equity mutual funds, such as large cap funds, mid-cap funds, and small-cap funds. Here, you can decide to invest in a large cap fund or small-cap fund based on your risk-taking capacity. A small-cap fund carries more risk than a large cap fund as a large cap fund invests predominately in large companies that are market leaders with strong financial positions. Large companies are better able to tide over business cycle downturns than small cap companies.
You might also have more than one goal. If your second goal is to buy a sedan in the next three years, then investing in equity funds for this goal might not be the best option. Debt mutual funds that are relatively less volatile than equity funds may help you achieve your goal of buying a sedan.