How to get the best out of mutual funds by avoiding common mistakes: Part 1

In November, mutual funds in India invested र 13,600 Crores in equities. These investments were made possible by participation of large number of retail investors in equity mutual funds taking tactical advantage of weakness in equity market. Equity mutual funds saw inflows of nearly र 9,350 Crores in October, the highest in the past 16 months. While this is surely a sign of growing retail investor awareness about mutual funds in India, many investors still make a number of mistakes, which prevent them from getting the best results from their mutual fund investments. In this two part blog post, we will discuss 10 common investing mistakes, which mutual fund investors should avoid.

1. Waiting for market to correct before investing:

   Mutual funds are ideal investment options for retail investors to help them in meeting a variety of financial goals. Some investors wait to time the market in order to buy at the lowest possible price. I have seen investors waiting for the market to correct to levels which some “experts” have forecasted. Investors should understand that, even the most experienced “experts” cannot correctly predict the market bottom.
   
   As per the Random Walk Hypothesis of stock prices, it is not possible to predict near term stock prices. Some investors think that the market is overvalued at some levels and they wait market to correct. However, if you are waiting for the market to correct, do you have a target price at which you will invest? You should understand that it is extremely difficult, if not practically impossible, to correctly call a market bottom. Many investors who exited their mutual fund investment in 2008 ignored calls from financial advisors in 2009 / 2010, thinking the market will correct further. In less than 24 months the market was 40% higher. At that point of time, some of these investors thought that the market has rallied a lot and it is not wise to invest at this level. In another 24 months the market rallied by a further 30%.
   
   If you have a goal based, disciplined approach to investing then you will not have regrets. You should understand the mutual funds are long term investments. At the end of the day, the market up or down will not make a huge difference to your long term goals. You should invest based on your goals, irrespective of market levels.



2. Investing in large number of funds to diversify risks:

   Mutual funds aim to diversify unsystematic risk, including stock specific risk and sector specific risk. Investing in a large number of funds does not necessarily lead to more risk diversification. To diversify the risk of potential underperformance of an individual fund, you can split your investments in a few funds. But if you invest in a large number of funds, there is a greater possibility that you will pick up underperformers, which will lead to sub-optimal portfolio performance. A large number of funds in your portfolio also make it more difficult for you to track performance and effectively manage your portfolio.
   
   Having a large number of SIPs of small amounts linked to different bank accounts also serves no useful purpose and compounds the problem further. Usually most investors have one or two bank accounts, where they get regular credits (e.g. salary, rent from property etc). The other bank accounts are used to park funds in savings account, fixed deposit etc. If your SIPs are linked to bank accounts which do not get sufficient credits, then you have to transfer funds from other accounts to these accounts, to ensure that you have sufficient balance in your bank accounts on each of the SIP auto debit dates. This is extra work for you and no extra benefit, because, as discussed earlier, investing in a large number of funds does not give additional diversification.



3. Monitoring your portfolio performance daily:

   There is a school friend with whom I regularly get together, once or twice every week after work, over a cup of coffee. Almost always I have seen him checking his phone at one particular time; he would then either be a little upset or happy. Since he is the regional sales head of a large FMCG company, I thought that, he was probably checking the daily sales report of his team. One day, out of curiosity, I asked him what he was checking and he said that, his wealth manager sends him a daily portfolio report at around 9 PM.
   
   Monitoring your portfolio performance on a regular basis is a good practice, but overdoing it, serves no purpose, except increasing your stress levels because equity markets are inherently volatile.
   
   Mutual fund NAVs are updated at the end of the day, based on the underlying asset prices. Based on the scheme NAVs, your mutual fund portfolio will have a different value every day. On days when your portfolio is down 2 - 3%, there is no reason to be upset because, it may be up 2 – 3% the next day and on days when your portfolio is up 2 - 3%, there is no reason to be excited because, it may be down the next day.
   
   Your portfolio value matters only when you need the money for your financial goals. From time to time, you should do a thorough review of your portfolio to see if you are on track to meet your financial goals, or to see if the schemes in the portfolio are not below average performers; if you are checking daily, you are merely checking, not analyzing. When I explained this to my friend, he understood, but he said that, checking his portfolio daily has become a habit. Why form a habit which is useless. Daily or even weekly portfolio checking for most investors is unnecessary; in fact, for equity mutual funds, a monthly review is more than sufficient. Whether you do a monthly, quarterly or even annual review, you should do a thorough one.



4. Panicking and redeeming investments in bear market:

   You do not need to be a Warren Buffet to understand that you make money in equities by buying low and selling high. Unfortunately many retail investors do exactly the opposite. They invest in mutual funds when there is hype in the market (bull market) and redeem in a bear market. It is very heartening to see that, the retail investors in India are showing a lot more investment intelligence. Large number of retail investors took advantage of the market corrections in 2015 and 2016 to tactically increase their asset allocation in equities. The improving investment intelligence notwithstanding, it is understandable that, investors will be stressed in bear markets, when they see their portfolio diminishing in value every day. I know some professional (institutional) investors, who know the investment business better than me, feeling stressed in bear markets. But retail investors have an advantage over professional investors in bear market, because a marked to market loss has no impact on retail investors unless they are selling, whereas it can have an impact on professional investors.
   
   Investors should understand the difference between volatility and loss. In a bear market, your portfolio value will be lower, causing you stress (maybe), but not a loss. You make a profit or loss, only when you sell. By redeeming your investment when the market has crashed, you do not gain anything.
   
   Bear market is not the end of the world. In my 18 year career, I have seen 4 bear markets; over the same period Sensex has risen nearly 800% and top performing mutual funds have given even higher returns. After every bear market, there is a bull market and not only does the market recover from the lows, but the resultant rally most often takes the market to a new peak. This is especially true in a growing economy like India. You should be calm in market corrections and be disciplined about investing. In fact, if you are smart investor, you can tactically increase your allocation to equity at every big correction, like many investors did in 2015 / 2016 and earned exceptionally good returns.

Conclusion

In this post, we discussed some common investing mistakes. By being financially disciplined and increasing your investment awareness, you can easily avoid these mistakes. In the next part of our post, we will discuss some more investing mistakes that you can avoid to get the best results from your mutual fund investments.

Disclaimer: