Mutual funds have attracted a lot of people recently.
People today are more enthusiastic about saving and investing than ever before.
However, this also makes investors prone to mistakes. And we are going to discuss and make investors aware of these mistakes through this blog.
Mistake Number 1: Starting without setting goals
This is a rookie mistake that we have seen most people make.
If you are investing in mutual funds, what is it for? Are you looking to stash away for your retirement? Are you investing to accumulate a corpus for your child’s college education?
It is very important to define your financial goals in as many details as possible.
Here’s what a rookie says – I am investing for my child’s education.
Here’s what a smart investor says – I am investing for my child’s education that is 7 years away. In today’s terms, I need Rs. 10 Lakhs in 7 years.
Then you apply a suitable rate of inflation to estimate the corpus that is required in nominal terms.
Once you have a number, you decide how you want to reach there – a lumpsum investment, a monthly SIP or a differentiated investment strategy like
AlphaSIP. This is dependent on a number of other factors like your current income, expected increase in income, liabilities etc.
Everything said, defining your financial goals should be the number 1 step always.
Mistake Number 2: Investing only in equity mutual funds
Equity mutual funds are more popular than debt mutual funds with retail investors.
However, it is important to know that debt plays a big role in your investment portfolio.
Debt is probably in your portfolio in the form of fixed deposits, PF or a government small savings scheme.
However, even your mutual fund portfolio standalone can do with some debt allocation.
Debt mutual funds give your portfolio stability and reduce drawdowns during times of stock market crashes. Here are a few ways to utilise debt mutual funds –
1. Short term commitments (less than 3 years)
2. Easy liquidity (liquid funds for periods like a few months)
3. For safety during the times of crises (if equity market seems overvalued and you expect a correction)
4. Falling interest rates (investing for capital gains)
5. For regular monthly cashflow
6. FMPs can provide an alternative to fixed deposits
Mistake Number 3: Leaving everything to your financial advisor
A classical mistake that investors make is leave everything to their financial advisors.
While it may seem like the smart thing to do – let the expert manage – it may not be wise always.
It is very important that you understand what your financial advisor is doing with your money.
There is a clear conflict of interest—your financial advisor is likely to earn his commission even if your investments don’t perform. A fee-only financial advisor is less likely to think of his own good before yours – but again, since his fee is not dependent on your portfolio performance, you should not feel a hundred percent with him as well.
Therefore, it is very important that you learn at least the basics. The basics would include – equity, debt, SIP, expense ratio, return calculation, types of mutual funds, taxation of mutual funds etc.
Once you feel you are comfortable with the basics of mutual funds, approach a professional. Ask him questions until he can answer them to your satisfaction. Don’t simply say yes to everything he advises. Ask him about risks more than you ask about returns.
Proceed only with a financial planner who has solved all your queries to your satisfaction and seems trustworthy.
Mistake Number 4: Don’t invest with your bank
This is just an extension of mistake number 3.
Bank officials are most likely to mis-sell you investment products.
And since these are familiar faces, you will most likely trust them with your life. But don’t!
Try to avoid taking investment advice from bank officials as much as possible.
Mistake Number 5: Don’t trust mutual fund star ratings/rankings
Mutual funds are rated by various websites. These ratings are completely objective—meaning, numbers based.
Let me put it this way – If Sachin scores less than Harbhajan in one match, would you conclude that Harbhajan is a better batsman than Sachin?
Another one – If Virat retires tomorrow and is replaced by a newbie, will team India be still as strong as it is today?
The first example is to let you know that just because fund A did better than fund B in the last one year, it doesn’t mean that fund A is better. One year is a very short time in the investment world—especially if we are talking of equity mutual funds. However, most ratings websites will tell you that fund A is better than fund B just because fund A did better than fund B in the last one year.
The second example is to let you know that fund manager changes are not accounted for by star ratings. Fund manager is the person directly managing you and other investors’ monies. If, for whatever reason, he quits tomorrow, how should you react? You should first check who the replacement is and if he has a track record comparable to the fund manager who left. If he is a new guy you’ve never heard of or whose track record is too short, you should wait and watch or simply move to a more reliable mutual fund.
Mutual fund star ratings and rankings have a number of critical shortcomings. These cannot and should not be relied upon for mutual fund selection decisions.
So, there you have the five critical mistakes you should avoid as a mutual fund investor.
Making great investment decisions starts with avoiding critical investment mistakes!
