Mutual funds investment is comparatively safer method of increasing your net worth. However these investments are not totally devoid of risks. These are the things you should take into account while deciding on a specific mutual fund for investment.
Performance
The first point you must consider is if the mutual fund you want to invest in is outperforming or underperforming the market. The stable and reliable mutual funds regularly outperform the market. Fluctuations in the net asset values (NAVs) of these mutual funds are regularly better than the market. E.g. if the stock index rises, the NAV of all the good and safe mutual funds will go up to the extent of the market movement or at times, can exceed the market movement. Also when the market goes down, the NAV of most good and safe mutual funds will go down, but such reduction will be equal to or less than the market movement. But in case of risky mutual funds, the opposite holds true. When the market rises, the NAV of risky mutual funds can go up but may be below the market and can even decrease, even though there is a bull run in the market. Avoid these mutual funds that are performing below par, while taking an investment decision.
The other thing to check is if the mutual fund has excessive “churn and earn”. This implies you should find out if the excessive transactions by the mutual fund lead to heavier fees or costs to the investor. The biggest culprits are the mutual funds who carry out needless churn. Every buying or selling transaction of the mutual fund fetches its broker(s) a nice hefty commission. Hence the brokers support plenty of churn by bribing the mutual fund manager. Since direct bribery is crime, the bribes are induced indirectly like sponsoring a family trip overseas or offering the mutual fund manager a plush Wall Street office at an unbelievably low monthly rental. The only person who loses in this game is the investor, especially if the fine print says the investor is responsible for the brokers’ fees too.
Absence of clarity
Mutual Funds that have prospectus, annual reports or statements containing extra information that is written in a convoluted way making it difficult to understand and hence should be avoided. Absence of clarity in documents signifies the shortage of honesty in their dealings or absence of competency in managing funds. Both these reasons are plausible enough to make you shun them for investing. Risky and unsafe mutual funds have innumerable restrictions on the method and timing of selling or redemption of mutual fund shares. Mutual funds with very long lock-in periods or charging heavy exit load while redeeming should be treated cautiously and turn out to be unsafe and risky.
Be wary of scams
There are quite a large number of mutual funds that are total sham. Many reports have indicted fund mangers selling stocks at different prices than those told to the investors. E.g. the fund manager can sell stock at prices that existed at the close of previous day, while the investor is informed that the stocks were sold before the close of the day, when the prices were quite lower. This allows the fund manager to keep the difference with them and since there is a large amount of such transactions, a small price difference can cause heavy gains for the manger. The only loser here is the investor who is shortchanged by the mutual fund manager.