Mistakes to Avoid While Investing In Mutual Funds
As investors, we learn and improve over time. Mistakes happen, and sometimes we don’t even notice them. These unnoticed mistakes can end up costing us.
This article explores common mistakes in mutual fund investing and offers insights on how to avoid them. Avoiding these errors is vital, as they can greatly affect your investment returns.
- Chasing Performance:
Chasing performance is a common mistake we’ve all made. It’s tempting to invest in a fund with impressive double-digit returns, hoping it will continue its winning streak. However, top performers change frequently, making it unlikely to sustain those returns over time.
- Investing in Sectoral/thematic Funds
From time to time, various sectors and themes experience market success. Investors often find sectoral and thematic funds appealing because of their short-term gains. However, these funds carry higher risk compared to diversified equity funds. One of the main challenges with sectoral and thematic funds is predicting which theme will perform well. Few investors can claim to consistently forecast this accurately. Complicating matters, the top sectors or themes frequently change.
- Investing heavily in mid and small cap funds
Similar to sectoral and thematic funds, mid- and small-cap funds garner significant interest. During bullish phases, these funds often deliver impressive returns, which many investors find irresistible. Naturally, there’s a strong inclination towards investing in mid-cap and small-cap funds. However, it’s important to recognize that these funds aren’t suitable for everyone. Investing in mid- and small-cap funds is advisable only if you’re comfortable with higher risk in exchange for potentially greater returns. If you prefer a more stable portfolio with fewer fluctuations, sticking with diversified equity funds would be more appropriate.
- Not reviewing your portfolio
Another common mistake investors make is neglecting to review their portfolio regularly. This practice is crucial as it helps mitigate risks and issues, ultimately enhancing returns. Consider this example from Mr. Atul’s portfolio: In 2014, he began investing in a tax-saving fund that initially performed well, outperforming key benchmarks for three years. However, its performance declined starting in 2018, consistently underperforming the benchmark thereafter. Regrettably, he only ceased his SIPs after four years of continuous underperformance in 2022. If he has to quit, he will have to wait until 2025 to withdraw entirely, thus being stuck with it. Had Mr. Atul reviewed his portfolio regularly, he could have halted his SIPs earlier, possibly exiting the fund entirely by 2022, thereby improving his portfolio returns.
A portfolio review isn’t solely about identifying underperforming funds. It involves assessing exposure to different asset classes, ensuring diversification, and evaluating fund strategies over time. There’s no such thing as a perfect or hopeless portfolio; only optimised and unoptimised ones, with a significant difference between them. Failure to review your portfolio compromises its quality. Top-performing funds can quickly become underperformers, highlighting regular reviews’ importance.
- Not starting with a financial plan
Many invest without a clear idea of their goals, akin to embarking on a journey without a destination in mind. Financial planning requires a roadmap as we plan vacations by deciding on a destination, setting a budget, and arranging accommodations and activities. Without it, investing becomes like shooting arrows in the dark. Even diligent SIPs and long-term focus can’t compensate for the lack of a financial plan. Without clarity, we’re left unsure how much to save for each goal, whether our SIP amounts are sufficient, or if adjustments are needed. Additionally, without an exit plan, achieving goals may be delayed due to unpredictable market fluctuations.
- Other mistake
Let’s revisit some additional common mistakes investors make in mutual fund investing:
- Opting for Regular Plans:
Regular plans involve distributor commissions, leading to higher expenses for the fund house and ultimately lower returns for investors. Direct plans, on the other hand, bypass these commissions, offering higher returns. Consider switching to direct plans for better outcomes.
- Choosing IDCW Option:
The IDCW option, previously known as the dividend option, may seem appealing for payouts. However, it’s not ideal for capital growth. Payouts from IDCW are irregular, taxed at applicable slabs, and subject to AMC discretion. Opting for the growth option is more conducive to capital compounding.
- Investing in NFOs:
New Fund Offers (NFOs) often attract investors with low Net Asset Values (NAVs), but this doesn’t necessarily indicate better performance. NFOs lack a track record, making it risky to invest. Instead, opt for funds with proven performance across market phases.
- Risking Short-term Money in Equity:
Investing short-term funds in equity during bullish market phases can be tempting, but it’s important to remember that past performance doesn’t guarantee future returns. Consider a fund’s worst performance over various periods to assess potential losses and invest wisely.
