“Mutual fund investments are subject to market risks” – this is the line you hear quickly uttered by the voice-over artist during advertisements urging you to become an investor. However, just being aware of market risks will not shield you from the mistakes you could be making when you invest.
We are bound to make a few mistakes in the initial phase of a new venture. It is no different from a mutual fund investment. But what if you had a strategic code to avoid these mistakes? This blog merely points out the mistakes you may make while investing in mutual funds. Let’s look at some of the common goof-ups.
Let us take “Mobile Phone” as an example to understand easily what we are trying to highlight in this Blog.
Example: Common mistakes people make while buying a mobile phone.
It is observed people make most mistakes while buying a mobile phone. They just consider 2-3 features and buy it. No proper in-depth research is done to actually buy a phone according to their needs.
- They consider the camera as the First Factor.
- They think the bigger the screen, the better the phone.
- They buy what is seen the most (in commercials or stores).
- They buy without knowing their own needs and requirements. (only RAM and storage don’t matter, there are other factors to consider too.)
- It is important to check the processor, OS version, audio quality, USB port, and so on.
Likewise, while investing with Mutual Funds too people consider 2-3 features and don’t analyze the complete picture. It is Important to buy Mutual Funds which suit your needs and Goals.
Top 5 Common mistakes people make while investing in Mutual Funds.
- Considering lower NAV Mutual Funds are better for Investment.
- “No need to Plan, just Buy any Fund and Hold” mindset.
- People do not consider taxation.
- People try to Time the market. People either Invest money in Single Fund or do Over-diversification.
1.Considering lower NAV Mutual Funds are better for Investment.
NAV means “Net Asset Value”. The significance of NAV for us is, we buy units of a mutual fund scheme at its current NAV. Like ‘share price’ is for stocks, ‘NAV’ is for mutual fund schemes. But the similarity of NAV with share price ends here itself. Why I say so?
Because lower is the share price the better. But we cannot say the same thing for NAV. Investing in Mutual Funds NAV is different from Investing in Stocks. In Mutual Funds, we want to create a long-term wealth-creating portfolio. On the other hand, in stocks, we look for potential quick growth.
Not all products which are cheaper are a good ‘buy’ opportunity. (e.g., sometimes bags or clothes that are cheaper when on sale are defective). Likewise, one company’s lower NAV than another does not mean it is a better investment than another.
Fund A: Fund B:
NAV = 100 NAV = 10
Returns expected = 12% Returns expected = 12%
10-years-old Fund. 1-year-old Fund.
It is better to invest in Fund A than Fund B as past Data is available to analyze and then invest.
2. No need to Plan, just Buy any Fund and Hold” mindset.
Mutual Funds are not like “Elastic Pants” which will suit everyone.
A 25-year old’s, a 45-year old’s and 65-year old’s portfolio need different strategic planning. In every stage of life, restructuring of Portfolio is necessary which would cater to the next Goal in life.
Financial Goals needs to be written down first (i.e., Retirement, House, Car, Vacation, Children’s Higher education and marriage, etc.) and then accordingly Plan should be selected which would suit each Goal.
3.People do not consider taxation.
People sometimes wonder why did they receive lower returns than the expected returns. Well, Taxation is one of the reasons. It is very important to know about the Tax implied over Mutual fund schemes you are investing in.
Indexation benefits applicable on Debt funds make them a better Investment product than Fixed Deposit (FD). Indexation increases your purchase cost and after adjusting inflation your returns seem to be less, so you have to pay less Tax. So effectively, Debt MF is more Tax efficient as compared to FD.
In the case of FD, expected Returns after Tax are nearly 4-4.5%. On the other hand, expected Returns after-tax in Debt Mutual Funds can be close to 8-8.5%.
4.People try to Time the market.
Yes, we agree, Restructuring and Rebalancing is very important but that does not mean you just invest a lot of money when markets are down and do not invest a penny when markets are up.
It is more important to follow a disciplined investing strategy and keep in mind your Long-term investment Goals.
5.People either Invest money in Single Fund or do Over-diversification.
Investing all your eggs into a single basket is the riskiest investment anyone can opt for. In fact, it is not even an Investment but rather speculation or gamble on a single Fund.
Mr. A invested Rs. 25,00,000 inherited after his father’s death into a company’s mid-cap Fund on the basis of its past performance. But suddenly the mid-cap sector’s stocks were falling and Mr. A’s returns were in Negative. (If he might have strategically diversified his Funds into different Schemes, his portfolio might have consumed less loss or nearly no loss)
Likewise, over-diversification is also not preferable. Over-diversification happens when the number of investments in a portfolio exceeds the point where the marginal loss of expected return is higher than the marginal benefit of reduced risk. Every time a new scheme is added, it lowers the risk of the portfolio to a very small extent. But at the same time, each additional investment lowers the expected return.
Other Important Point: Investors only see CRISIL ratings and past returns which is not appropriate.
CRISIL is an Indian analytical company providing ratings, research, risk, and policy advisory services. Some Investors tend to Invest in Mutual Funds just because of their CRISIL ratings, they do not analyze the whole picture. Their analysis can sometimes be inaccurate and biased.
Yes, I agree Past performance is important but you just cannot rely on Past performance to invest in a particular MF scheme.
Mr. A invested in a company’s Hybrid fund by just seeing its past performance. He did not analyze other important factors. He did not even know the Fund manager had resigned who was behind such consistent returns. From next Quarter, returns were lower and at the end of the year, returns were at their lowest point.
There are a lot of things to consider and research before investing in a Mutual funds scheme.
If you Don’t have proper knowledge about where to invest your hard-earned money, it is sensible to approach a professional Financial Advisor who can guide you to allocate your Corpus (Funds) into the different Asset classes. This will diversify your risks and generate higher returns.
We at Tstock Mantra Investments by Amruta Tushar Ghone provide complete Financial Planning for an individual i.e., Mutual Funds, Insurance planning, Retirement planning, and so on.
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