Common mistakes to avoid while investing in mutual funds

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It would not be an exaggeration to say that all retail investors are aware of the fact that ‘mutual fund investments are subject to market risks and one should read the offer documents carefully before investing.’ But simply reading the offer documents carefully is not enough to ensure that your investments will deliver results as per expectations.

The popularity of mutual fund investments has skyrocketed in the last few years, thanks to the simplicity and flexibility afforded by these investment vehicles. According to a report by Crisil, India’s mutual fund industry is likely to grow in double digits, and the asset under management is expected to cross Rs 50 lakh crore mark over the five years through 2025. But, there are a few mistakes that many retail investors, especially those who have just been introduced to the world of mutual funds tend to make.

Giving in to the narrow outlook

For mutual fund investors it is easy to fall into the trap of basing an investment decision based on short-term returns and having unrealistic expectations of returns. Parvati Iyer, chief investment officer at Femwealth.com, an online wealth management platform says, “The single biggest mistake that most investors make is in selecting mutual funds based on near term returns. In fact many investors gravitate towards funds that top the 1 year leader board. Just looking at the performance of the last couple of years leads to wrong choices.”

The same erroneous strategy is also adopted by many investors when exiting mutual funds. Vikas Gupta, CEO at Omniscience Capital says, “While it is important to gauge the performance of mutual funds, what investors should focus on is long term performances rather than recent performances. Many of them make the mistake of exiting a mutual fund since the recent performance has been bad. Investors should understand the objective of the scheme before picking a fund and the investment processes adopted by the fund manager. If it makes sense to you, then you should be prepared to have periods of underperformance and ride them out.”

Iyer also advocated that the trick is to keep a tab on the performance of the fund of the last few years. “If a fund has not been doing well for a year, many investors panic and sell them. This reaction is emotional. Instead of short term fluctuations, sustained poor performance over a few years should be the trigger as most funds go through patches of low returns,” she opines. According to a survey of 18 financial advisers conducted by LiveMint in 2017, approximately 72% of the respondents confirmed that a majority of investors buy funds solely based on past returns.

Say no to over diversification

While diversification is one of the golden rules to go by when building a resilient portfolio, going overboard can defeat the whole purpose of mutual fund investments and for many investors, it is very easy to slip into the diversification overdose zone. Deepak Chhabria, CEO of Axiom Financial Services Pvt Ltd says, “Too much diversification tends to flatten the return curve. For instance, if you have investments of Rs 50,000 in two mutual funds and its value climbs to Rs 70,000, the returns would be decent but imagine if your investment was spread across ten funds then you would have been makling a profit of Rs 300-400 on some while the others could be incurring losses. Management of a large number of funds can also take away your focus and become a problem especially if you have too many funds and majority of them are underperforming.”

Iyer also highlighted that too many funds often lead to a lot of overlaps and the advantages of diversification are lost. “It is common to see investors having multiple funds of the same style and that is of no use,” she says.

Jumping into the deep end too early

Over enthusiasm among new investors who are yet to understand the intricacies of mutual fund investments can also prove to be dangerous. Chhabria says, “Investors who have only recently started mutual fund investments should only stick to large and multi-cap funds. There have been instances where investors got carried away and invested in sector and thematic funds which need a higher level of expertise. These funds tend to be more volatile and cyclical in nature and investments in them require a certain level of timing in exit and entry. Investors should only invest in these funds after they have attained a certain level of skill with regards to the tricks of mutual fund investments.”

Chhabria believes SIPs are the best route for mutual fund investments for those who are yet to gather the required knowhow and until then such investors should avoid making lumpsum investments in mutual funds. “Systematic investment plans ensure the benefit of rupee cost averaging which generate higher returns than random lump sum investments. You don’t have to worry about timing the market either and the room of error is lesser compared to that of a sudden lumpsum investment scenario.”

Key Takeaways:

•Do not forget to enlist a nominee when investing in a mutual find scheme to avoid problems and the hassle of legal paperwork later on.

•Knee jerk reactions to market cycles defeat the advantage of mutual funds that are designed to work over bull and bear cycles. As is true with most things in life, for mutual fund investments to bear fruit it is important to exercise patience and not get too carried away by market cycles.

•Keep yourself updated of the news cycles and of the latest developments in the arena of mutual funds.

•Seek advice of financial expert to pick your investment product.

This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund