In the recent years, awareness towards Mutual Funds are attracting large number of new investors, owing to the facts that, many first time investors are in search of new investment avenues with banks cutting interest rates, up-trending stock market and the emergence of online investment platforms and eKYC, mutual fund investing for beginners has become very convenient and hassle-less.
However, the lack of proper understanding about mutual funds and capital markets leads to various wrong investment decisions by the investors, which prevents them from getting the optimal results. Completely ignoring mutual funds is also one of the biggest mistakes that majority of investors make. Here are some of the other common mistakes that first-time fund investors often make.
- Finding the funds with low NAVs:
Many mutual fund distributors often convince the first-time investors that funds with low NAVs are cheaper. However, this is not true. Investors should understand that NAV of a fund is determined by the value of its underlying assets and the total number of its outstanding units, and it can be high or low due to various reasons. A relatively new fund will have a lower NAV while an old fund with excellent performance over the years will have a very high NAV. Similarly, the NAV of better performing fund will increase faster than a ‘not-so-good’ fund over the same time period. Instead of NAV, an investor should rather consider a fund’s past performance along with its future potential to deliver high returns. For example, assume that you have an option of buying either of two mutual funds. Fund A, which has a NAV of ₹25, has delivered an annualized return of 15 percent p.a. Fund B, having a NAV of ₹10, has delivered an annualized return of 6 percent p.a. So, which mutual fund should you prefer? Obviously, the mutual fund delivering higher returns. Thus, never use a fund’s NAV as a criterion to buy mutual funds.
- Choosing the fund without considering risk appetite and financial goals and other factors:
It is also one of the common mistakes committed by a majority of investors. They pick up schemes based on the advice of their relatives or friends, without considering their needs, without due research and analysis. Before making an investment, you must ascertain your investment goal, return expectations, and the risk you can take with your capital. Based on those requirements, determine the tenure for which you want to invest in a fund, ascertain whether you want to invest a lump sum, or systematically over a regular interval, and accordingly pick the fund best suited to those requirements. You must analyze the fund’s past performance, expense ratio, current portfolio, and all other parameters for best returns. This is especially important if you’re investing for the long term, since picking the wrong fund would mean missing your target by a long margin.
- Not diversifying enough:
Many first-time investors of mutual funds invest their entire investible surplus in just one mutual fund or in the funds of a particular sector. However, instead of putting all eggs in one basket, diversify your investments by investing in different types of funds offered by different fund houses.
For example, Mr. X has invested ₹1Lakh each only in the banking funds of five different fund houses, we cannot call it diversification. His portfolio could have been considered diversified if he had invested in five different mid-cap funds. Thus, even if a particular fund underperforms its benchmark index or peer funds, investments in other funds may save the day for you by providing higher returns.
But diversification does not mean adding too many schemes to the portfolio, especially on the equity side, adds no value to your portfolio, increases the burden of tracking them and may lower the potential of your portfolio to generate superior returns.
- Not focusing on Asset Allocation:
Asset Allocation simply refers to the proportion in which you invest in various assets depending on the parameters such as- your age, qualification, income, current assets and liabilities, marital status, number of dependents, need for liquidity, risk appetite etc. If you do not follow a proper asset allocation strategy, you are putting your hard-earned money at risk. Even the best performing mutual funds cannot provide you returns if the asset allocation is incorrect. We must understand that different asset classes perform differently at various points at various points of an economic cycle, mutual funds are also prone to the same. So, stocking up on similar assets in your portfolio can give you a rude shock when the cycle turns unfavorable.
You can also take the help of your financial advisor to assess your risk profile and get the right asset allocation for your profile. For example, your financial advisor might recommend the following asset allocation based on your risk profile and investment preferences.
Real estate: 30%, Debt: 10%, Gold: 5% and equity: 55%
Within equity allocation, he might recommend (40% allocation to large-cap funds, 25% to multi-cap funds, 30% to mid-cap and small-cap funds and remaining 5% to sector funds).
- Too much attention to short-term performance:
As highlighted above, different asset classes offer different results at various stages of an economic cycle. Additionally, within an asset class, say equities, stocks from different sectors (technology, pharma, banking, FMCG, agriculture etc.) and types (large-cap, mid-cap, small-cap) may perform better than the others. So, a fund which had higher exposure to the stocks of a particular sector, at the time of its outperformance, is likely to generate more returns than other funds and the fund performance shall suffer when the sector underperforms. The credit for this outperformance should go to the fund manager for using an effective strategy. However, this could also be due to fund manager’s preference/bias towards that particular sector or sheer good fortune. Too much attention to short-term performance can also make you build an unduly large exposure to sector funds, which can, in turn, hinder your portfolio.
- Lack of investment discipline:
A Large crowd of retail investors gets attracted towards equity funds when markets are making newer highs. Subsequently, when the markets crash and start hitting fresh lows, investors grow frustrated with their losses and exit their investments. Again when the markets are making newer highs, greed takes over and they start investing and then sell again when the market crashes incurring losses. And the cycle goes on.
No one can deny that equity mutual funds are inherently volatile products but there is no point trying to time the markets. So, to take care of this behavioral problem, investors should make regular investments in the mutual funds regardless of the market levels. This can be done by setting up a systematic investment plan (SIP). Investment through SIPs takes care of the behavioral problem, brings discipline to investing and provides the benefit of rupee cost averaging.
- Investing in mutual funds to earn dividend:
Some distributors project dividend as some sort of a windfall or bonus earning. However, what these advisors don’t disclose is that the dividend is paid out of your own investment only. As soon the mutual fund scheme pays a dividend, the NAV of that scheme gets reduced by the amount of the dividend paid. For example, assume that a scheme with NAV of ₹50 declares a 30 percent dividend. As soon as the scheme pays you the dividend (₹3,30 percent of face value), the NAV of that scheme will come down to ₹47. In effect, the mutual fund pays back your own money. Instead, you should opt for the growth option to benefit from the power of compounding.
- Unrealistic expectations from equity-oriented mutual funds:
Most first-time mutual fund investors invest in equity-linked schemes during the bull-phase. Initially, during this phase, these mutual fund schemes provide exceptional returns, which leads the investors to build unrealistic expectations about future returns. As a result, many of them compromise their liquidity by channeling their entire surplus into such equity funds. Others invest in these funds to make quick returns for their short-term goals. However, returns generated during the bull phase are unsustainable. As and when the markets start to correct, such investors start to liquidate their mutual fund investments fearing further losses or to meet their short-term financial requirements.
- Not reviewing your portfolio:
Most of the investors do not monitor the performance of their portfolios. They invest based on the recommendation of their mutual fund advisor and then do not care to see how their investment is doing. Some financial advisors are also to be blamed for not actively or even regularly reviewing the portfolio of their clients. It is the responsibility of your advisor to review your portfolio performance, with you at regular intervals.
But this does not mean you start monitoring the portfolio on a daily basis. It will prove to be a useless exercise, serving no purpose except increasing your stress level. It is because of the inherent volatility of equity-market, some days markets will be up and on other days the market will be down. When the market is down, it is obvious that your portfolio will underperform. But it does not mean that you have made a poor investment and will not be able to meet your goals.
- Investing only for saving tax:
Investments up to ₹1,50,000 in equity-linked saving schemes are exempt under section 80 C. In fact, ELSS is the shortest lock-in product (3 years) in the basket of investment products allowed for exemption under section 80C. First-time investors get an additional benefit under Rajiv Gandhi Equity Savings Schemes (RGESS). This is why retail investors flock to such schemes in the months of February and March to save taxes. Investing lump sum amounts into such funds increases the market risk to an extent and does not give you the benefit of rupee cost averaging.
While there is nothing wrong in saving taxes, principles of mutual fund investing do not change just because you have been extended tax benefits by the government. Such funds shall be chosen to keep your entire asset allocation in mind and investors should take exposure to such funds through systematic investment plans.
It is very important to avoid these mistakes while making your investment to significantly improve your chances of investing success.