Here are 5 mistakes that you should avoid when you invest in Mutual Funds:
Mutual Funds are perhaps the best instrument to generate steady wealth over the long-term. They are also an ideal investment vehicle for retirement planning. After all, with an MF, you get investment exposure to various sectors without having to depend on individual stock picking. But all Mutual Funds are not created equally. Picking the wrong one that does not suit your investment objectives, could do more harm than good to you. In India, unfortunately, investing in equities is highly influenced by myths and wrong sentiments. With that in mind, I have listed below five common Mutual Fund investment mistakes you can avoid:
Investing without a plan
Mutual Fund investments should be based on financial goals. However, the majority of the retail investors in India have no such goal, whether formal or informal. They mostly invest on an ad-hoc basis, guided by the advice of friends, relatives, family members. As a result, most people end up with incorrect investment decisions, and more often than not they break their equity investments to meet their short-term objectives.
Every stage of our life has unique goals. Buying a house, for instance, could be the most important goal in your thirties. Retirement, which is still 20-25 years away, may not be that important if it doesn’t really bother you. Again, in your late thirties, providing for the higher education of your children could be a priority than other investments. However, in your entire investing lifecycle, some priorities will be more important than others.
A financial plan will help you prepare for every financial priority in each stage of your life. Without a plan, you would be prone to make further mistakes.
A classic case of ad-hoc investing is investments in tax saving mutual funds i.e. ELSS schemes. The fact that ELSS has the shortest lock-in period of 3 years, makes investors flock to this in the month of Feb and March. While tax saving is not bad, lump sum investments in ELSS instruments increases market risks to an extent and doesn’t give the rupee-cost averaging benefits. Tax saving should always be incidental to your investment objectives which in turn should be guided by your financial life goals.
Timing the market
Many people hold on to their money waiting for an appropriate moment to begin their investments. I believe that timing the market could prove to be a bad strategy, especially for the long-term investors. The time is nothing but a comfortable level which the investor thinks perfect to enter the market. Investors, in most cases, are not rational. They attach too much importance on current events, ignoring the past performance of a fund and its future potential. The result? There’s frenzied buying when the market is high and frantic selling when it is low.
The best way to ride market volatility is to invest regularly in a disciplined manner. And the best time to start investing is “NOW”. A systematic investment plan (SIP) is the best option in this regard. It allows rupee-cost averaging, where you can buy more units when markets slide. Remember, there’s no “perfect” time to begin MF investments. It’s important to continue investing regardless of market conditions. Do keep in mind that Wealth creation takes time.
Frequent Reshuffling of portfolio
Most people are guided by market news appearing on TV channels/mainstream media and keep reshuffling their portfolio, leading to erosion of value. You must have a solid reason to reshuffle your portfolio. Simply because the fund rating has dropped from five-star to four-star or the fund manager has quit doesn’t mean you should reshuffle in a hurry. The fact is that, there are various rating agencies and portals like value research and Morningstar which rate mutual funds; the same mutual fund might be rated differently by different agencies. Also, the ratings tend to change frequently based on the inclusion of new funds.
Pressing the panic button
It’s natural for investors to feel stressed in a bear market. This is when investors tend to pause their SIPs or redeem their existing investments. This kind of irrational behaviour is usually driven by the herd mentality or the fear factor to avoid further downside. The fact is that, you will only loose by panic selling when the market tanks. At best, you get a mental satisfaction that you didn’t lose more money. But if you invest for the long term based on your goals, then volatility and mark-to-market valuation of your portfolio would hardly matter.
Bear and bull phases are fundamental cycles of the equity market. The bull phase follows the bear, and not only the market recovers from its lows, the resultant rally often takes it to a new high. This is particularly true for burgeoning economies like India. So when the market tanks, you should actually be re-balancing your portfolio rather than selling your funds.
Investing in too many funds
More often than not I get queries from investors asking for the optimal no. of Mutual Funds in their portfolio. Recently, an investor mailed me his portfolio which had 12 MF schemes at a total monthly SIP of Rs. 30,000. He chose the top-performing equity fund from different categories, based on their five-year returns. The investor failed to understand that each category has its own objective which may or may not match his risk profile. Also, over diversification doesn’t mean less risk. It, in fact, could be riskier and likely to generate lesser returns. Investing in too many funds, in most cases, leads to overlapping of investments in the same company or industry sector. It’s meaningless to invest in the same stocks via different schemes. Moreover, greater the number of schemes, more cumbersome and time taking it will be to track them.
Mutual Funds invest in diversified portfolios of debt, equities, gold, etc. Hence, you should choose a fund from a category that best suits your risk profile as well as your financial goals. For instance, a young and aggressive investor can invest as much as 80% in equity funds for his retirement goal. People with a medium risk profile can choose a balanced fund, while a conservative investor can go for debt oriented portfolio. Once you are aware of your risk profile and prioritized your goals, you can devise a minimalist portfolio with a maximum of 1-2 mutual funds in a portfolio per goal and a maximum of 4-5 funds in your overall mutual fund portfolio.