Know your goal: It’s not about ‘risk appetite’ but more about your investment horizon. There are two parts to this: the time-frame and the flexibility of the time-frame. When are you likely to need the money? And when the moment arrives, can you postpone the need by few months/year or so?
Time-frame: It helps you to decide what type of fund you need to invest in. The time-frame can be divided into three baskets, in descending order of importance: 1) Over five years 2) Six months to five years; and 3) immediate to six months.
Right choice: Once you are clear about the time-frame, you need to know which fund to pick. For long-term investments, it should be a diversified equity fund, where a fund manager has the maximum flexibility to invest across companies of different sizes. For medium-term investments, it means bond funds and for short-term funds, it means liquid funds.
Track record: In case of an equity fund, look for a long track record. Here, ‘long’ is not an arbitrary length of time but one that captures a full market cycle. A fund manager who has done well over an entire cycle has a better claim on your money than one who has done brilliantly in a short span. In the Indian context, seven years is good enough to judge performances. Look for stability in fund management: it’s important that the person/team behind the impressive record is still with the fund.
Cost: In case of bond and liquid funds there is hardly any differentiation in performance, but low cost and economies of scale do add up to better returns. Therefore, a low-cost, large fund is a better choice.