How to Compare Mutual Funds?

Investing in mutual funds is a great way to grow your wealth over time, but selecting the right fund can feel overwhelming with so many options available. 

Each mutual fund has a specific purpose, from wealth creation and capital preservation to generating regular income. 

While simply choosing the fund with the highest return might sound appealing, this approach often overlooks critical factors such as your financial goals, risk appetite, and the fund’s consistency in performance.

Mutual funds vary regarding returns and their structure, costs, and investment strategies. 

For instance, an equity fund might promise higher growth potential but come with a higher risk, while a debt fund may offer stability but moderate returns. 

This is why comparing mutual funds is essential—it ensures your investment aligns with your needs and helps you achieve your financial objectives more effectively.

In this blog, we will explore the key aspects you should evaluate when comparing mutual funds. Understanding these factors will equip you with the knowledge to make informed decisions.

Why is Comparing Mutual Funds Important?

Key Factors to Compare Mutual Funds Comparing mutual funds isn’t just about finding the one with the highest returns. It’s about selecting a fund that meets your specific needs:

Financial Goals

For instance, if you want to save for retirement 20 years from now, equity funds with a growth focus can be more suitable than debt funds aimed at preserving capital.

Risk Tolerance

Some funds are more volatile, which might not suit conservative investors. For example, a mid-cap equity fund can have higher price fluctuations than a government bond fund.

Cost Efficiency

Small differences in expense ratios can significantly impact return over time. A fund with an expense ratio of 1% will take a smaller chunk of your returns than one with a ratio of 2%.

Long-Term Impact

Funds with consistent performance and lower volatility can be more reliable for building wealth over time.

Investment Objectives

Every mutual fund has a stated objective, often aligned with a specific financial goal. Understanding this helps ensure your goals and the fund’s purpose match.

Equity Funds

Invest primarily in stocks and are ideal for long-term growth. However, due to market volatility, they come with higher risks.

Hybrid Funds

A mix of equity and debt, these funds balance growth and stability. They’re suitable for moderate-risk investors aiming for steady returns.

Debt Funds

Focus on bonds and fixed-income securities, making them suitable for short-term goals or conservative investors. A liquid fund might work well for emergency savings.

Example: If you are saving for your child’s education five years from now, a balanced hybrid fund can be more suitable as it offers growth and stability.

Fund Performance

Past performance is an important metric, though not a guarantee of future success. Here’s how you should evaluate it:

Absolute vs. Annualized Returns

Absolute returns show how much the fund has grown in a specific period, while annualized returns standardize this growth into a yearly format, making it easier to compare.

Rolling Returns

Instead of focusing on fixed periods (e.g., last 1 or 3 years), rolling returns (average annualized return) measure performance over overlapping periods. This gives a better idea of consistency, irrespective of market cycles.

Benchmark Comparison

Check whether the fund has outperformed its benchmark index. For instance, if a large-cap fund hasn’t consistently beaten the Nifty 50, it may not justify its fees.

Peer Performance

Compare funds within the same category to avoid misleading comparisons. A debt fund can’t be compared to an equity fund because their objectives differ.

Example: A fund delivering 15% returns during a bull market when its peers average 12% is a strong performer. However, check its performance during bear markets, too.

Expense Ratio

The expense ratio represents the percentage of your investment deducted annually for fund management and operational costs.

1. Direct Plans: These have lower expense ratios because they exclude distributor commissions. Direct plans are more cost-effective for do-it-yourself (DIY) investors.
2. Regular Plans: These include distributor fees and have higher expense ratios. Choose regular plans if you prefer professional advice and assistance.

For example: There are two funds, A and B, with expense ratios of 1% and 2%, respectively. Over 10 years, assuming a consistent 12% return, Fund A would deliver significantly higher returns due to lower costs.

Risk Measures

Understanding risk is critical for choosing funds with risk tolerance. Common risk measures include:

1. Standard Deviation: Indicates the variation in a fund’s returns. A high standard deviation means the fund’s performance is volatile. Example: Fund A with a 15% standard deviation is more volatile than Fund B, with 10%.

2. Beta: Measures sensitivity to market movements. A beta of 1.2 means the fund is 20% more volatile than the market. High-beta funds are better for aggressive investors in bullish markets, while low-beta funds suit conservative investors.

3. Sharpe ratio: Shows risk-adjusted returns. A higher ratio indicates better returns for the level of risk.

Fund Manager’s Expertise:

The fund manager plays a vital role in delivering performance. Factors to evaluate:

1. Experience: A seasoned manager with a strong track record across different market conditions is preferable.
2. Consistency: Frequent changes in fund management can disrupt investment strategies and affect returns.

Example: If a fund manager successfully steered funds through volatile periods like 2008 or 2020, it reflects well on their capability.

Portfolio Composition

A fund’s portfolio shows where the fund has invested the scheme asset under management (AUM). Look for:

• Sector Allocation: Funds heavily concentrated in one or two sectors, such as IT or pharma, are riskier than diversified funds.
• Top Holdings: The fund might depend heavily on a few stocks if the top 10 holdings form a large part of the portfolio.
• Geographical Exposure: Check if the exposure aligns with your risk appetite for international funds.

Example: A fund with 50% exposure to cyclical industries may suffer more during economic downturns than a well-diversified fund.

Liquidity

Liquidity refers to how easily you can redeem your investments.

1. Open-ended Funds: Allow redemptions at any time, providing high liquidity.
2. Close-ended Funds: Restrict withdrawals until maturity, making them less flexible.
3. Exit Loads: Some funds charge a fee if you redeem investments within a specific period. Check these charges before investing.

How to Compare Mutual Fund Performance?

1. Use Mutual Fund Comparison Tools: Platforms like MutualFundWala offer side-by-side comparisons of multiple funds. These tools let you analyze returns, risk measures, expense ratios, and peer rankings at a glance.
2. Evaluate Consistency Over Time: Look for funds that deliver consistent returns over 1, 3, 5, and 10 years. Funds that perform well in both bull and bear markets indicate stability.
3. Check SIP Performance: For systematic investment plans (SIPs), review returns generated from regular investments over time.
4. Compare Peer Funds: Select funds in the same category for comparison. For example, large-cap funds should only be compared with other large-cap funds.

Example: Comparing Two Equity Funds

Metric	Fund A	Fund B
5-Year Annualised Return	12%	14%
Expense Ratio	1.1%	1.8%
Sharpe Ratio	0.8	1.0
Beta	0.9	1.2

Analysis: Fund A is less volatile (lower beta) and has a lower expense ratio, making it more suitable for conservative investors. Fund B offers higher returns but at greater risk.

Conclusion

Selecting the right mutual fund is not a one-size-fits-all process. You should thoroughly analyze your goals, risk tolerance, investment timeline, and a detailed review of the fund’s past performance, costs, and portfolio composition. By comparing funds based on these parameters, you can ensure that your investment aligns with your financial plan.

While focusing solely on returns is tempting, remember that a well-performing fund isn’t necessarily the best choice if it doesn’t align with your objectives. Factors like expense ratios, risk measures, and fund manager expertise can significantly impact your long-term gains. 

Additionally, leveraging MutualFundWala comparison tools can simplify the process, enabling you to evaluate multiple funds efficiently and make confident decisions.

Investing wisely requires a mix of research, strategy, and patience. Use the insights this guide shares to compare mutual funds effectively and build a portfolio that helps you achieve your financial aspirations.