Avoid these mistakes while Investing in mutual funds

Sharp correction of March 2020 and subsequent quicker recovery has attracted many investors to the equity market. The majority of them are investing through mutual funds. I wish to warn these new investors against the novice's mistakes while investing in equity mutual schemes. Let us discuss some of the major mistakes.

Making investments without linking them with any financial goal

Your investments should always be linked with some specific financial goals. It can be education and your children's marriage, buying a house, a foreign vacation, or even your retirement. If there is no goal, wealth creation is also a valid goal. The product for investments will differ depending on the tenure of the purpose, criticality and flexibility of the purpose. A foreign trip or house purchase can wait but not the education or marriage of your children. Since one has to move the accumulated corpus in equity to a safer product as the goal nears, this cannot be done unless the investments and goals are linked.

Not defining the amount of money required to meet financial goals

Some investors have an idea of the financial goals they need to achieve and the timeframe in which they want to achieve them. However, these investors do not define the amount they need to achieve those goals. Let us consider some examples. If you know that you want to retire at the age of 50, or need money for your children’s education 15 years down the line, you need to estimate the amount you would need. Factor in inflation, and then calculate the amount you would need to invest per month based on the products you plan to include in your asset allocation. Regularly monitoring your investments goes a long way towards helping you achieve your goals in this way.

Expecting unrealistic returns

The recent rally has made people believe that equity can always give excellent returns and have set their return targets very high. It would help if you can be realistic on returns that your mutual fund investment would generate. In my opinion, your equity mutual funds should give you around inflation + 6% return in the long run, and one should be happy with that.

Expecting consistent returns in the short term

Equity investment gets you higher returns in the longer run, but in the short term, it may even land you in losses. So to expect consistent returns like a fixed deposit from equity investing is the mistake many novice investors commit. One should be aware that the returns here are not consistent and are volatile, so the product is risky for a short tenure.

Treating dividend option as regular income

Any dividend paid to you in any mutual fund scheme is effectively paid out of your fund's NAV (Net Asset Value) and thus effectively goes out of your pocket. The NAV of your scheme comes down, after the dividend, to that extent. Moreover, the dividends are taxed at your slab rates, but if you opt for growth option while investing in mutual funds, the short term profits are taxed at 15%, and long term gains enjoy full exemption up to 1 lakhs, and the balance is also taxed at concessional rate of 10%. So for those in higher tax slabs, it makes sense not to opt for the dividend option. However, there may be situations where opting for a dividend option may be beneficial. Please get it evaluated by your tax advisor in advance.

Non-diversification or over-diversification in fund houses and schemes

One should not put all his eggs in one basket, and this philosophy should be implemented by asset allocation while investing. While making investments, one should diversify across asset classes, like equity, debt and gold. Moreover, the assets have also to be periodically rebalanced. If you follow the principle of asset allocation and do rebalancing periodically, you will undoubtedly be able to maximize your returns. So in case one does not follow the asset allocation, even one major correction in the asset class may result in wiping out the profits. It may result in losses as well as different asset classes do not always move in the same direction.

Even while investing in a mutual fund, you should diversify your investments across mutual funds and various categories of funds. Ideally, you should have no more than five equity schemes in the portfolio. You should also not invest in any and every scheme which is doing good. 

Lack of research

There are hundreds of schemes available in the market. Before investing, it is always a good idea to get a clear overview of your assets and financial goals before you can build an effective roadmap. This includes preparing your own risk profile, which depends on your goals as well as your thought process about investing. A risk-averse investor may choose to invest a lesser proportion in equity, while someone who does not want to take as many risks will opt for something else. If you wish to invest for 7-10 years or longer, then equity is a great choice for you.

All these choices can be made once you sit down and review your goals and finances. It is equally important to do research about the market. For example, it may not be a good idea to go by the ranking of a mutual fund scheme before deciding to invest in it. Investment is for the future, while the rating is based on past performance. It is important to know their expense ratio, asset size, the company and the fund manager, as well as their past performance. If you can do it on your own, by all means, do it. If not, you can take help from a financial advisor.

Not taking stock of the performance of the investments periodically.

Reviewing your investments periodically is an essential part of the investment journey. Even when you link your investments with a specific goal, you still need to check on the performance of your investments to see whether it is progressing at the projected pace; else, you may have to either increase the amount of the investment or moderate your goals. Please note that reviewing is also injurious. You should not look at the performance of your equity schemes every month and take corrective steps. Ideally, you should check it once a year.

Investing in mutual funds based on NAV (Net Asset Value)

Novice investors evaluate the equity schemes based on their NAV, and schemes with lower NAV look cheaper to them, and that is why many investors rush to subscribe to NFO (New Fund Offer) at NAV of 10 rupees.

Attempting to time the market

Novice investors generally get panicky when the market corrects and withdraws and stops their ongoing investments through  Systematic Investment Plans (SIP), fearing further fall. As the saying goes, you should be greedy when everyone else is fearing and should fear when everyone else is greedy. Correction is the right time to invest more rather than withdraw your investments.

Thinking in isolation

Make sure to pick the right schemes that suit your risk profile as well as your goals and investment patterns. Do not focus on the investment cost only. Go for a direct plan, but only if you can take care of all the factors discussed above, and can take timely calls and regularly monitor your investments. Otherwise, enlist the help of a financial advisor who can help take that burden off your shoulders and enable you to focus on your job or business. You are your own stock and the returns you get from your career cannot be replicated through investments. If you feel the need for an advisor, go for it. An advisor can give you the edge in terms of selecting schemes suitable for you.

This article will surely help new investors appreciate the pitfalls they should avoid in their investment journey.

For more information on this visit www.taxaj.com.

Posted by Pooja

Team Taxaj

 

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