How to Select Mutual Funds
The Complete Guide
A systematic approach to building a 3-fund portfolio for long-term wealth creation. Learn the 8-point checklist, fund types, and common mistakes to avoid.
Why This Guide?
Mutual funds are one of the most accessible ways for beginners and intermediate investors to participate in the stock market. However, with thousands of funds available, choosing the right ones can be overwhelming. This guide simplifies the process by focusing on a proven 3-fund portfolio approach that balances growth potential with manageable risk.
Build long-term wealth through systematic investing, not speculation
Understanding Fund Types
Instead of spreading your investments across 10+ funds, focus on just 3 solid performers. Each fund type serves a specific purpose in your portfolio:
Flexi Cap Fund
- Invests across all market caps
- Lower volatility, steady growth
- Examples: Parag Parikh Flexi Cap, Axis Bluechip
Mid Cap Fund
- Higher growth than large caps
- Sweet spot for Indian market
- Examples: Axis Midcap, Kotak Emerging Equity
Small Cap Fund
- Highest growth potential
- Needs patience (7+ years)
- Examples: Axis Small Cap, SBI Small Cap
Funds to Avoid
Thematic funds (IT, Pharma), International funds, NFOs (New Fund Offers), and Index funds (until you understand active vs passive investing). These add unnecessary complexity for beginners.
Next: Learn the 8-point checklist to filter winning funds
8-Point Fund Selection Checklist
Use this comprehensive checklist before picking any mutual fund. Each criterion helps you filter out underperformers and identify consistent winners:
1. Rolling Returns (5Y+)
Check 3-year and 5-year rolling returns, not point-to-point returns. Rolling returns show consistency across different market cycles.
What to look for: The fund should beat its category average consistently across multiple rolling periods. Avoid funds with erratic performance.
2. Expense Ratio
Direct plans should be less than 1% for equity funds. Even a 0.5% difference compounds to lakhs over 15 years.
Pro tip: Always choose Direct plans over Regular plans. Regular plans cost 1-1.5% extra annually, which can reduce your returns by ₹5-10 lakhs over 15 years on a ₹50 lakh investment.
3. Fund Manager Tenure
The current fund manager should have at least 3+ years of experience managing the fund. Avoid funds with frequent manager changes.
Why it matters: A fund's performance is heavily influenced by the manager's decisions. Frequent changes indicate instability and can disrupt the fund's strategy.
4. AUM Size (Assets Under Management)
The fund should have adequate AUM to ensure liquidity and operational efficiency, but not so large that it becomes difficult to manage.
Ideal AUM ranges:
• Large/Flexi Cap: ₹5,000 Cr+
• Mid Cap: ₹3,000-10,000 Cr
• Small Cap: ₹2,000-8,000 Cr
Balance is key - too small means higher risk, too large means reduced agility.
5. Standard Deviation (Volatility)
Measures how much the fund's returns fluctuate. Lower standard deviation means more stable returns, which is important for risk management.
What to look for: Compare the fund's standard deviation with its category average. A fund with similar returns but lower volatility is generally better for long-term investors.
6. Sharpe Ratio (Risk-Adjusted Returns)
Measures returns relative to risk taken. A higher Sharpe ratio means better risk-adjusted performance.
Interpretation: A Sharpe ratio above 1 is good, above 2 is very good, and above 3 is excellent. Compare funds within the same category for meaningful insights.
7. Portfolio Overlap
Check if your chosen funds hold the same stocks. High overlap defeats the purpose of diversification.
Best practice: Keep portfolio overlap under 30% between your funds. Use online tools to check overlap before finalizing your selection.
8. Exit Load
A fee charged if you redeem your investment before a specified period (usually 1 year). Most equity funds charge 1% exit load if redeemed within 1 year.
Planning tip: Since you're investing for 15+ years, exit load shouldn't be a major concern. However, be aware of it to avoid unnecessary charges if you need to rebalance early.
Now you know what to look for. Let's set up your portfolio.
Setting Up Your 3-Fund Portfolio
Once you've selected your funds using the 8-point checklist, follow this simple 5-step process to get started:
Choose Platform
Use Groww, Kuvera, or Coin by Zerodha for direct mutual funds.
Pick 3 Funds
1 Flexi Cap, 1 Mid Cap, 1 Small Cap using the 8-point checklist.
Set SIP Amounts
Start with ₹5,000/month: ₹2,500 Flexi + ₹1,500 Mid + ₹1,000 Small Cap.
Automate Everything
Set up auto-debit for all SIPs on the same date (1st or 15th).
Stay Disciplined
Don't stop SIPs during market falls. Increase by 10-20% during corrections.
Avoid these common mistakes that cost investors lakhs
Common Mistakes to Avoid
Learn from others' expensive mistakes. Here are the most common errors that cost investors lakhs over the long term:
Choosing funds based on last 1-year returns
Past performance doesn't guarantee future results.
Buying regular plans (costs 1-1.5% extra)
Always choose Direct plans to save on expenses.
Having too many funds (>5)
Over-diversification dilutes returns and complicates tracking.
Stopping SIPs during market crashes
Market falls are buying opportunities, not exit signals.
Switching funds frequently based on news
Patience and consistency beat market timing.
Not checking portfolio overlap
Same stocks across funds = false diversification.
Investing in NFOs without track record
New funds lack performance history for evaluation.
Trying to time the market
Stay invested for long-term wealth creation.
Quick Summary
Pick 3 fund types
Flexi Cap, Mid Cap, Small Cap
Use 8-point checklist
Filter winners systematically
Setup SIPs with proper allocation
50% Flexi + 30% Mid + 20% Small
Avoid common costly mistakes
Stay disciplined and patient
Disclaimer
This guide is for educational purposes only. All examples are for understanding and not investment recommendations.
Mutual funds are subject to market risks. Past performance doesn't guarantee future results. Please consult a SEBI-registered advisor before investing.
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