Top 5 Mistakes to Avoid When Investing in Mutual Funds
Are you looking for an option to invest with returns higher than fixed deposits and where taxes levied are lower than your bank deposits? There is no denying the fact that mutual funds are the best alternative to these instruments if you are keen on wealth accumulation by balancing risk and returns. By far it is the best possible way to achieve your long-term financial objective and assimilate wealth efficiently minimising your tax burden. By managing risk, the potential return they offer surpasses inflation. However, being pragmatic, staying focused and maintaining patience are the three crucial criteria to be a successful investor.
Nevertheless, you must have heard others sweating over returns and facing unfavourable circumstances during a market downturn. More often than not the reason for such a situation results from an investor's irrational discretions rather than the non-performance of a fund.
Top 5 Investment Mistakes You Should Avoid
“To err is human…”- it is natural to go wrong with your investments if you are easily swayed by your peers or their experiences or even market trends. You need to choose the funds carefully in line with the below factors to avoid any such obvious mistakes :
1. Investing Without a Clear Goal
Avoid any goal ambiguity you have before you start investing. Ensure to set a clear long-term financial objective if you want your investment journey to culminate in wealth creation. Set your long-term goals like retirement, higher education for children, wedding etc. and then start investing aligning the choice of funds with your objectives. This will aid in deciding the tenure of your investment. Market performances undergo cycles of outperformance and underperformance. Longer tenure helps your portfolio to tide over such low phases. Besides, having a specific goal leads to disciplined investment and cautious decisions about the choice of funds. It prevents you from making hasty decisions about market entry and exits and fosters efficient portfolio management.
2. Ignoring Risk Appetite
Profiling your risk appetite is a crucial aspect of mutual fund investments. With age your risk profile becomes conservative and your risk appetite becomes low as you become risk averse as earnings shrink. Young professionals fresh out of college have a higher risk appetite as time is on their side and also due to the propensity of income increase. Middle-aged family men are moderate risk-takers and prefer to strike a balance between risk and return. Accordingly, for a senior investor, a profitable mix of high debt exposure and low equity exposure is appropriate. A high investment in equity offering high returns would be preferable for a young aggressive investor. A family man prefers a balanced exposure to equity, debt and hybrid funds with moderate to high risk and returns.
3. Chasing Past Performance
One major blunder that you can make as a beginner is choosing funds based on only past performance. Undoubtedly, it is easier and more rewarding to opt for funds showing consistent growth patterns over 1,3 and 5 years, but past performances can never guarantee future success. Rather it is wise to allow a minimum of 2-3 years before assessing a fund's performance.
You should also keep in mind other factors like the efficiency and reputation of the fund managers, the expense ratio which indicates the administrative and AMC management costs and the total assets under management of the fund. These indicators impact your net gain considerably.
4. Timing the Market Instead of Staying Invested
Very often you will find investors trying to maximise returns by timing the market, which is buying when the market is low and selling when it hits high. Although it is an ideal situation to gain a short-term boost in returns, it is fraught with risk. Even seasoned and experienced investors are baffled when they try to predict short-term market movements. Thus, staying invested and setting a long-term goal for withdrawal makes more sense if you want to take advantage of high market returns. Once you remain invested, your portfolio returns start looking up due to the compounding effect, dividend reinvestment and also overall market growth.
Frequently shuffling your portfolio and withdrawing funds renders these impacts ineffective.
The best way to negate such possibilities is investing via SIP mode. With a systematic investment plan, any short-term volatility is checked and risk mitigated due to the rupee cost averaging technique and compounding returns. Since it is a regular monthly investment of a fixed amount it helps accumulate units when the market is low.
5. Neglecting Expense Ratios and Exit Loads
Sometimes you might get blindsided by a fund performance and neglect certain other aspects which may impact your long-term returns. A high expense ratio means the management and administration cost of a fund is steep. Though it might seem very insignificant initially, if we consider the long tenure, it may turn out to eat away at your profits heavily.
Also, you need to check for the exit load that is charged while you redeem. Some mutual fund schemes charge high exit loads if you redeem in the short term, especially within a year. Restricting premature exits helps build higher investment earnings.
Conclusion
Investing in mutual fund is not tough even for a beginner, if you can keep these tips and tricks in mind. Think carefully about your objectives for wealth creation, the time when you need the invested funds and how much risk tolerance you have. Then carefully choose funds considering their fund manager credibility, rolling returns, expense ratios and exit loads. Explore the composition of funds to consider your equity and debt exposure. Then, curate a portfolio that aligns with your risk capacity and return expectations. If you are uncertain, choose to invest via the Systematic Investment Plan (SIP) for a disciplined way to allocate funds and take advantage of risk dilution via rupee cost averaging and higher return due to compounding. A regular review also helps in monitoring your allocation and helps manage your funds better. Once you decide on the tenure, a Mutual Fund Calculator will give you an idea about the capital gains and expected maturity amount of your invested funds. So take baby steps and start investing small through SIPs and build your wealth without panic and fear.
