KNOWLEDGE CENTRE Mutual Funds Investment Guide / How to Select Mutual Funds Using Risk Ratios?

How to Select Mutual Funds Using Risk Ratios?

Mutual funds are considered as a lucrative investment option. Considering the different schemes available in the market, it can get confusing for the investors to make a choice. Based on the long-term financial goals and the tenure, an investment avenue should be chosen. Mutual funds offer diversification of the portfolio and carry a low risk with a high return probability.

What are mutual fund risk ratios?

Like stocks, mutual fund risk ratios can help judge the worthiness of a fund. The ratios are studied by fund managers to decide whether to invest or not. Investors need to understand the implication of the ratios before making an investment decision.

Here are a few risk ratios that can help you judge the investment worthiness of the fund:

  1. Dividend yield
  2. Market cap
  3. Sharpe ratio
  4. Standard deviation
  5. Beta ratio
  6. Alpha ratio

Let us try and understand each one of these mutual fund risk ratio in detail:

What is dividend yield of mutual funds?

The dividend, which is distributed by mutual funds, is the dividend yield. It is compared as a percentage to the market price of the fund. Higher the dividend yield, higher the return on investment. Indian companies do not usually give a higher dividend; hence, a dividend yield of 3% or more is ideal for an investment in mutual funds.

What is market cap of mutual funds?

The market cap is important in order to make the right investment option. It gives information about the investment of the fund across different securities. It will provide information whether it has been invested into large cap, mid cap, or small cap. Market cap also provides information to the investors about the expected risk and return of the fund. A large cap fund invests in blue-chip companies that have already established themselves and offer a decent but stable rate of return.

What is Mutual fund Sharpe ratio?

Sharpe ratio helps to measure the return with respect to the risk. It is ideal to choose a fund with a high Sharpe ratio as it shows that the fund has higher returns as compared to the risk taken.

What is Standard deviation of mutual funds?

Standard deviation is another important ratio when selecting a mutual fund. It helps to determine the variance in the returns of the fund. It also helps analyze the consistency with which the returns are generated from different mutual fund schemes. With a high standard deviation, the returns will be highly fluctuating; hence it is ideal to invest in a fund with a low standard deviation.

What is Beta ratio of mutual funds?

The beta of a mutual fund measures the ups and downs of the fund based on the market movement. The beta ratio shows the change in the Net Asset Value(NAV) of the fund with a certain movement in the overall market. A low beta is good since it shows that the NAVs will not drastically change with the highs and lows in the market. A beta of 1 is perfect and it shows that the returns will be inclined to the benchmark returns.

What is Alpha ratio of mutual funds?

The alpha will give you information about the mutual fund performance as compared to the benchmark index. Alpha ratio measures the return and risk in relation to the benchmark index. A high Alpha means the better performance of the fund.

Loads present on the buying and selling mutual funds

There is no entry load at the time of purchase of mutual funds but there is an exit load and the same is applicable when you redeem the fund before the specified tenure. Usually a load of 1% is applicable at the time of redemption; however, certain fund houses forego the same if you hold the fund for a longer duration. Learn more about the entry and exit loads of a mutual fund here.

If you can easily interpret the mutual fund risk ratios, you will be able to compare different mutual fund schemes when selecting a mutual fund. Many mutual fund schemes provide the ratios hence there is no need to calculate the same, but it is important to understand the relevance of it when making the investment choices. Considering the number of investment options available in the mutual fund industry, it is advisable to compare the ratios and choose the fund that meets your investment requirements. Keep in mind that the mutual fund performance will be driven by the ratios and the market movement.

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