How to Choose Mutual Funds for Beginners in 2025

Feeling lost in the world of investments? With so many options available, choosing the right one can feel overwhelming. If you're exploring mutual funds, which is a popular choice for both beginners and experienced investors to grow their wealth. In this article, we will explore what mutual funds are, how to choose mutual funds, how to evaluate them based on goals, costs, and performance, and even behavioural tips to avoid mistakes. Let us dive deep to understand more.

What are Mutual Funds?

Mutual funds are investment vehicles where investors’ money is pooled together and, in return, they are issued units. These funds are then invested across a range of securities such as stocks, bonds, government securities, and other investment securities. Diversification across sectors and industries helps reduce the risk of investments going wrong, and it can be offset by good investments. Mutual funds share profits or losses proportionately with their unit holders (investors).

Mutual Fund schemes vary based on the investment objectives from time to time. Every Mutual Fund must be registered with the Securities and Exchange Board of India (SEBI), the market regulator, before it starts collecting funds from the Public Investors.

What are the Types of Mutual Funds

After understanding mutual funds, let’s explore the two major classification types based on structure and asset class.

Based on Structure

• Open-Ended Funds: These funds actively sell and redeem units to investors at any time. You can buy or sell these fund units directly from the fund house at any point. The fund's size changes as money flows in and out from investor transactions based on market demand.

• Close-Ended Funds: These funds issue a fixed number of units during a New Fund Offer (NFO). After the offer period, the units cannot be sold or bought from the Fund House by the unitholders. However, you can trade these units on a stock exchange, which is similar to company shares. These funds usually have a fixed maturity date, after which the fund returns the investment to the unit holders.

Based on Asset Classes

• Equity Funds: These invest primarily in company stocks. While they hold potential for high returns, they also come with high risk, which is suited for long-term goals typically more than 5 years. They are sub categorised based on company size (Large-cap, Mid-cap and Small-cap), specific industries (Thematic or Sectoral) or investment style (Growth, Value).

• Debt Funds: Debt funds invest in fixed-income securities such as bonds and government securities. They are lower in risk compared to the equity funds, offering more stable but generally lower returns. It is better suited for short to medium term goals (less than 5 years). Some of the examples include Corporate Bond Funds, Ultra Short Duration Funds, and Gilt Funds.

• Hybrid Funds: These funds invest in a mix of equity and debt instruments. It aims to balance risk and return. It is more suited for moderate risk-taking investors with a 3 to 5 year period. Examples include aggressive and conservative hybrid funds.

• Money Market Funds: These invest in high-quality, short-term debt instruments with maturities typically less than a year. Known for their high liquidity and low risk, they include commercial papers, certificates of deposit, and government securities.

How to Choose Mutual Funds for Beginners

Once you understand mutual funds and their types, here’s how to choose mutual funds for beginners using simple and effective steps:

• Investment Goal: Begin by clearly listing out the events and your investment objectives. The events such as property purchase, children's education, retirement corpus, dream vacation based on these factors, one needs to choose the mutual funds. For example, equity funds provide long-term benefits due to its higher returns potential. Likewise, debt funds are looked for shorter periods. Hybrid or Balanced Funds for medium term. You need to understand the risks and returns involved on which you are targeting to acheive. This is the foundation of how to select mutual funds or how to select mutual funds for investment in India.

• Risk Tolerance: Understand your ability to bear losses. SEBI has categorised mutual funds based on six levels of risk such as Low, Low to Moderate, Moderate, Moderately High, High and Very High. Use these parameters as a guide to align investments with your comfort zone. Further, understand the mutual fund category landscape before investing.

• Time Horizon: Determine your investment time frame. The mutual fund categories perform according to the allocation dynamics over the period. For example, Liquid funds address short-term goals ranging from 1 day to 3 months, followed by Ultra short duration funds ranging from 1 to 3 years, balanced and hybrid funds ranging from three to five years and equity funds for longer durations.

• Choose the Right Type of Fund: Decide between Equity, Debt or Hybrid Funds. Each of these funds performs independently. Most of the mutual funds are open-ended funds, giving you flexibility. Based on your risk profile and time horizon, it is crucial on how to choose best mutual fund.

• Starting with SIP Instead of a Lump Sum: Begin with a Systematic Investment Plan (SIP). SIPs apply rupee cost averaging, which involves buying more units when the market falls and fewer when it rises. This strategy helps you to earn better returns, potentially achieving a lower average cost per unit over the long term. It helps in fostering discipline in investing.

• Decide between the Direct vs. Regular Plan: In a direct plan, you invest directly with the fund house, which leads to a lower expense ratio. Regular plans involve investing through a distributor, who receives a commission, thus facing a higher expense ratio. Direct plans often offer better long-term returns if you are comfortable managing your investments.

• Read the Fund Factsheet: Before investing, make sure you read the Fund Factsheet. This crucial document includes fund's key features, investment objective, strategy, expense ratio, and asset allocation. By reviewing the Fund Factsheet, you can understand the fund's potential risks and rewards and determine if it aligns with your individual financial goals and risk tolerance.

How to Choose the Best Mutual Fund 

After going through how to choose mutual fund for beginners, we will look at some factors on how to choose the best mutual fund and keep these in mind on how to choose mutual funds for SIP as well. Here are some of the factors:

• Define Your Investment Goal and Timeframe: You should clearly state your financial goals (like retirement) and your investment timeframe. It will help you to select the right mutual fund type.

• Assess your Risk-taking Ability: You should understand your comfort level with how much risk you can bear. Based on that scenario, you should place your investments and choose the funds that match your ability to handle market ups and downs.

• Analyze Historical Performance: Before investing, make sure you take a look at the fund's historical returns across different market cycles. But the decisions should not be made based on the recent performance. The fund’s performance will vary based on the allocations, and you can look at rolling returns and calendar year returns to analyze fluctuations.

• Check the Expense Ratio and Other Costs: Always notice the expense ratio before investing and any other hidden costs involved, as it can impact the investment returns. Lower costs the costs, returns are better.

• Evaluate the Fund Manager and Fund House: The Fund Manager is a professional who manages your money through a fund. So check out the fund manager's experience and the fund house's reputation. Skilled management can often leads to better investment returns and protects capital. 

• Look for Consistency of Returns: You can prefer funds that demonstrate relatively stable and consistent performance over time. Over the period, consistency matters and it can provide an overview of return expectations.

• Consider the Fund Size: Before investing into a fund, you look at the size of the fund or Assets under Management (AUM), which states the total assets the fund manages. You can understand that large funds often showcase stability and more invested people have trust due to its performance. However, Large funds might face challenges in generating high returns due to huge asset base.

• Understand Exit Load and Redemption Policies: Exit load means if you withdraw funds before a certain lock-in period, it attracts a minor penalty. Make sure your investments are aligned to your plans as it can affect your returns and it can be avoided. Further, when funds are withdrawn, AMCs take typically 3 to 5 days to deposit funds to your account. So based on these scenarios, you can plan your finances.

• Plan for Regular Reviews: Periodically review your fund's performance and ensure the fund still aligns with your financial goals and risk tolerance. Your needs might change over time. You can change or add more mutual funds to diversify your portfolio. 

Investment Costs Related to Mutual Funds

After looking at the factors to choose the best mutual funds, we will look at some of the costs associated with them:

• Expense Ratio - The fee paid to the fund house by the investor. It is denoted as the total operating expenses divided by the average net assets, which is expressed as a percentage.

• One-time charges - These are paid during the Initial investments known as Transaction charges. 

• Entry Load - Charges applied at the time of investment (now abolished for most schemes).

• Exit Load - Charges for early withdrawal, usually within 1 year.

• Management Fee - Paid to fund managers for professional oversight. In most cases, it will be included in the expense ratio.

• Switch Fee - Applicable when switching between one mutual fund to another.

• Recurring Fee - This fee includes portfolio maintenance, marketing, and other expenses usually deducted from a fund’s NAV. 

• Distribution and Service Fee - In regular plans, this fee is paid to mutual fund distributors.

Behavioural Bias

At certain times, we feel confident in timing the market to perfection, which is based on certain results going our way, and it involves a bias. For successful investing, it requires emotional discipline. Here are some of the common behavioral biases to be aware of:

• Recency Bias: Avoid judging a fund solely based on its recent performance. For example, thematic or sectoral funds in areas like defence, consumption, or manufacturing may have performed well recently due to temporary market trends. However, due to business cyclicality, these sectors may experience downturns, impacting returns. Always focus on long-term consistency instead of chasing short-term gains. Similarly, reducing allocation to large-cap funds and shifting more into mid-cap or small-cap funds after recent rallies can backfire when market dynamics change.

• Herd Mentality: Your investment decisions should be based on your individual financial goals and risk tolerance, not on what friends or family are doing. Others may have different time horizons or risk appetites, so blindly following them can lead to investments going bad. Stick to your plan and make informed choices that suit your needs.

• Overconfidence: Don’t overestimate your ability to pick winning mutual funds or time the market. Trading frequently, ignoring professional advice, or investing heavily in specific sectors based on personal conviction can all lead to subpar returns. Be realistic about your knowledge and always rely on data and expert insights to guide your investment strategy.

• Loss Aversion: Market downturns can make losses feel more painful than the satisfaction of gains. This may cause you to hold onto poorly performing funds too long in the hope of a rebound or sell good-performing funds too quickly out of fear. These reactions can limit your long-term growth. Instead, stay calm and be focused during market volatility. Being invested often yields better outcomes over time.

How to Invest in Mutual Funds through Rupeezy?

Investors who are starting their investing journey for wealth appreciation can invest in mutual funds through platforms like the Rupeezy App, which offers a variety of options after necessary KYC compliance and other formalities. The Mutual Funds provide benefits to investors, such as diversification, risk tolerance, regulatory oversight, and smaller investment opportunities, which can be in a few hundred rupees.

A Quick Checklist on Choosing the Right Mutual Funds 

Before investing in the mutual funds, you can go through the checklist to make informed decisions.

• Does it match my investment goal and time horizon?

Choose a mutual fund that fits your specific financial goal, like saving for a house, a child's education, or retirement. Also, match the investment period; long-term goals often suit equity funds, while short-term needs go well with debt or liquid funds.

• Is it suitable for my risk profile?

Understand your comfort with risk. If you prefer stable returns, pick low-risk debt funds. If you're okay with market ups and downs for higher returns, go for equity funds. Always match your funds with your ability to handle market fluctuations.

• Has it shown consistent performance?

Check if the mutual fund has delivered steady returns over the past 3 to 5 years. This shows how well it performs across market conditions and helps you avoid funds that only did well temporarily.

• Is the fund manager experienced and reliable?

A skilled fund manager uses experience to make smart investment decisions. Look for someone with a strong track record and consistent results. Their decisions directly impact the fund's performance.

• Are the expense ratio and exit load reasonable?

Funds charge fees like an expense ratio (yearly) and an exit load (if you sell early). Lower costs mean more of your returns stay with you. Always compare these charges before investing.

• Is the portfolio transparent and well-diversified?

Check if the fund clearly shows where it invests. A diversified portfolio spreads money across different sectors, reducing the impact of any one investment performing poorly.

• Are exit loads and taxes understood?

An exit load is a fee if you withdraw early. Also, gains from mutual funds are taxed differently based on type and holding period. Knowing these will help you to plan better and avoid surprises.

Conclusion

In this article, we explored the meaning of mutual funds, their types, features, common biases, and investment costs. Choosing the right mutual fund is a mix of understanding your goals, risk tolerance, and investment timeline. With the right knowledge and a disciplined approach, especially by starting with SIPs and choosing the appropriate plan type, you can set yourself on a path towards financial independence. Whether you're a beginner or someone looking to diversify your investments, mutual funds can be a reliable way to build wealth when chosen thoughtfully.