How to Choose a Mutual Fund: Guide to select the best fund in 2025

How to choose a mutual fund remains one of the most potent techniques for wealth accumulation over time. With so many mutual funds available today, selecting one becomes tricky. From determining the scope of investment, whether you are a beginner or an expert investor, formulating the best fund requires calculating several metrics like the level of risk one is willing to take, the expected outcome of the investment, or how the fund has performed so far.

In this blog, we will describe detailed guiding criteria for how to pick a mutual fund that best captures your financial preferences and goals.

1. Define Your Investment Goals

The very first step toward choosing a mutual fund is determining investment objectives. Consider asking yourself: 

• What is the time horizon of your investment, short or long term? 

• Are you trying to increase your wealth, save money for a house, or have an emergency fund? 

• Are you looking to receive regular payments or increase the value of your capital? 

Your answers will contribute to deciding which type of mutual fund is most suitable.

Investment Target and Corresponding Mutual Funds:

• Short-term (13 years): Ultra short-term funds, liquid funds

• Medium-term (35 years): Debt funds, hybrid funds

• Long-term (5+ years): Index funds, equity mutual funds, ELSS (for tax saving)  

2. Evaluate Your Risk Tolerance

Every investor has a specific risk tolerance. Certain individuals are more comfortable with the volatility, but others appreciate stability. Here’s the most simplified guide:  

• High-Risk Capacity: Equity funds (thematic funds, large-cap, midcap, smallcap)  

• Moderate Risk Capacity: Hybrid funds (debt and equity mix)  

• Low-Risk Capacity: Debt funds (gilt funds, short term funds, liquid funds)  

If you are a beginner, starting with either a hybrid or an index fund would be a good starting place.

3. Select the Most Suitable Type of Mutual Fund  

Mutual funds are classified under various categories-

a) Equity Mutual Funds  

Equity funds primarily invest in stocks and are ideal for long-term wealth building. There are further subdivisions as follows:  

• Largecap Funds: Invest in top 100 companies (stable, moderate risk)  

• Midcap Funds: Invest in midsized companies (higher risk, better returns)  

• Smallcap Funds: Invest in smaller companies (highest risk, highest return potential)  

• Sectoral & Thematic Funds: Invest in specific sectors (highly volatile) 

• Index Funds: Passively track stock market indices (low cost, good for beginners)  

b) Debt Mutual Funds  

They invest in fixed-income instruments like bonds and treasury bills. They have less risk compared to equity funds, hence, they are divided as:  

• Liquid & Ultra Short-term Funds: For parking surplus cash (low risk)  
  
• Short-term & Medium-term Debt Funds: For middle-term investors of 25 years  
  
• Gilt Funds: Invest in government securities (safe but interest rate sensitive)  
  
• Corporate Bond Funds: Invest in high-rated corporate bonds (moderate risk)  

c) Hybrid Funds  

Composed of equity and debt, hybrid funds show a balance between risk and returns. Types include:

• Aggressive Hybrid Funds (Heavy Equity) – Moderate risk, higher returns
  
• Conservative Hybrid Funds (Heavy Debt) - Low risk, stable gains
  

 d) ELSS (Equity Linked Savings Scheme)

•  A tax-redeemed mutual fund with a lock-in span of 3 years
  
•  Tax deduction eligible via Section 80C (deduction doesn’t exceed Rs.1.5 lac annually) 

 4. Fund Evaluation

Be sure to analyze the fund’s returns during the chosen period (1, 3, 5, 10 years) before making any investment decision. Evaluate in comparison to other indices or mutual funds such as Nifty 50, and Sensex. 

Category-wise Fund Performance

Primary Factors to Review:

• Returns: Compare investments with the fund’s competitors in the previous quarters.
  
• Risk Ratios: Assess Sharpe Ratio, Alpha, Beta (the higher the Sharpe Ratio the better the results).
  
• Consistency: Look for funds that over the years have been successful through various market cycles.
  

 5. Think About the Expenses Ratio

Your investment management fee, paid to the fund house, is called the expense ratio, which is a portion of the revenues of the fund house allocated for operating and administrative costs. Fewer expense ratios allocated means you earn more money.

• Lower expense ratios exist in both direct mutual and index funds.

• The cost of actively managed funds tends to be greater.

Expense Ratio Comparison

 6. Analyse the Past Performance of the Fund Manager

The choice of who manages the fund can significantly alter its performance. Analyze the fund manager’s prior experience, history of performance, and personal management styles.

7. Analyse Ratings and Reviews of the Fund

Funds are rated according to their performance, as well as a risk-reward ratio at Morningstar, Value Research, and CRISIL. These ratings and reviews assist in making an educated guess regarding the funds.

8. Pick Between OneTime Investments or SIPs

You can contribute towards a mutual fund in two different ways:

• Lump Sum: Investing a large amount of money one time only (recommended for proficient investors during a recession).
  
• SIP (Systematic Investment Plan): Monthly investments of a fixed amount (mitigates the uncertainty caused by market fluctuations).
  

A SIP is beneficial for new investors who want to form disciplined spending habits.

9. Check Penalties for Withdrawal and Lockin Duration

A few mutual funds impose a fee for withdrawal (exit load) if redemption takes place before a predetermined duration. There is also a lock-in period of three years for ELSS funds. Always bear these in mind before investing.

10. Learn About The Taxes That Will Apply

Taxes that will be imposed on mutual funds depend on the specific type of fund and the period you hold it for.

Equity Funds:

For Short-term (under a year), it is 15%. 
For Long-term (over a year) it is taxed at 10% after Rs.1 lac exemption. 

Debt Funds:

Short-term is taxed under the income slab. 
Long-term after 3 years gains are taxed 20% only with the indexation benefit.

Funds like ELSS enable tax savings linked with deductions under Section 80C.

Conclusion

Making the Right Choice Choosing a mutual fund is a blend of adequate financial planning and thorough research accordingly. This guide to selecting the best mutual fund in India in 2025 will set you up to make impartial decisions and invest in mutual funds thoughtfully. 

Disclaimer:

Not a buy or sell recommendation. No investment advice is given. Past returns do not guarantee future returns. This Mutual Funds analysis is provided solely for informative purposes and should not be considered investment advice. Always conduct research and talk with a financial advisor before investing.

Faqs

• How to choose the correct mutual fund?

Consider factors like the level of risk one is willing to take, the expected outcome of the investment, or how the fund has performed so far.

• What is the 8-4-3 rule in mutual funds?

According to this general guideline, money rises consistently during the first 8 years, then accelerates for the next 4, and then experiences a snowball effect for the final 3 years.

• Can I withdraw SIP anytime?

Yes, SIPs can be withdrawn anytime but early withdrawal can incur exit load.

• Is SIP good for long term?

Yes, SIPs are considered good for the long term.

• Is SIP 100% safe?

SIPs are subject to market volatility and risks associated with the mutual fund plan.