Avoid these 10 mutual fund investing mistakes

1. Trying to time the market: Some investors wait to time the market in order to buy at low price. As per the Random Walk Hypothesis of movement of stock prices is random, in other words, it is not possible to predict short term price movement based on trend. Bear markets in the past have shown a sudden trend reversal. Even if you see a trend reversal, you can never be sure whether it is a genuine mean reversion or simply a bear market rally. Instead of investing in mutual funds based on market levels, you should have a goal based disciplined approach to investing. The market ups or downs in the short term will not have much impact on your long term goals. You should invest based on your goals, irrespective of market levels.


2. Investing in large number of funds: Mutual funds aim to diversify unsystematic risk, i.e. stock and sector specific risks by investing in a diversified portfolio of securities across multiple industry sectors. Investing in a large number of funds does not necessarily lead to more risk diversification. If you want diversify the risk of 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.


3. Monitoring your portfolio daily: Mutual fund Net Asset Values (NAVs) are updated at the end of the day based on the underlying asset prices. Based on the scheme NAVs, your mutual fund portfolio can be up or down on any particular day. Your portfolio value matters when you need to redeem your units to meet your financial goals. From time to time, maybe quarterly or annual, you should do a thorough review of your portfolio to see if your mutual fund schemes are outperforming or underperforming. But daily or weekly or monthly portfolio checking is unnecessary and in most cases, a waste of time.
   
   Suggested reading 5 points to remember for your asset allocation


4. Panicking in bear markets: In equity investments, you make a profit by buying when price is low and selling when price is 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. You should understand the difference between volatility and loss. You make a profit or loss, only when you sell. By redeeming your investment when the market has crashed, you will make a permanent loss; on the other hand, volatility results only in notional. Bear markets do not last forever; markets eventually recover and make new highs. You should remain calm and disciplined in market. In fact, if you are smart investor, you can tactically increase your allocation to equities in major corrections to get higher returns.
   
   You may also like to read why is the equity market falling and what should investors do?


5. Booking profits when returns are high: This is actually a trader mentality which unfortunately, some mutual fund investors also have. What is profit booking? When you are trading, you may have a price target in mind and will book profits when the price target is reached. But the same approach cannot be applied to mutual funds. Mutual fund investments are about financial goals, not price targets. When you are booking profits in your mutual fund portfolio, you are likely to redeem more units of your better performing funds because these funds will be giving you higher profits. As a consequence, you will be losing out on the compounding impact on your wealth creation, which these funds could have given you over long investment horizons. Avoid making this mistake because this will harm your financial interests in the long term.


6. Hanging on to underperformers: Some investors are hesitant to redeem mutual fund schemes which have underperformed over sufficiently long investment horizon, or worst, has made a loss. If they need liquidity, they will rather redeem units of fund which has given higher profits. Why? Because you do not want to sell at a low price. You should try to avoid this mistake. You should understand the difference between stocks and mutual funds. In mutual funds returns are more important than NAVs. If a mutual fund has not able to beat the benchmark index returns over a sufficiently long period (3 years or more), then you should consider whether you should switch to a better performing fund.


7. Redeeming equity funds before exploring other options in exigencies: There can be situations when you are in urgent need of liquidity. Sometimes mutual fund investors resort to redeeming their mutual fund units because open ended equity funds which have been held longer than the exit load period present easy liquidity compared to liquidating Bank FDs which may have penalties for premature withdrawals. This may not be a wise decision. Redeeming your mutual funds, especially equity funds, to meet unplanned expenses can have adverse impact on your long term financial goals because of the opportunity cost; the mutual fund you redeemed, may have given you much higher returns than Bank FD. As part of good financial planning discipline you should set aside some emergency funds in a liquid fund to meet any exigency.


8. Investing in debt funds based on past returns: Mutual fund literature usually has a disclaimer “Past performance may or may not be sustained in future”. However, many investors still invest based on recent returns. You should avoid making this mistake, especially in the case of debt funds. Debt fund returns are based on prevailing interest rates, the yield curve and bond spreads. In an environment where interest rates are changing, debt fund returns will also change. A long duration debt fund may give high returns when interest rates are falling, but it will give lower returns when interest rates are rising. You should select debt funds based on their yields to maturity (YTMs), duration and your investment tenure / risk appetite. You should also pay attention to credit quality of the fund.
   
   Suggested reading: Why you should have debt funds in mutual fund portfolio?


9. Ignoring tax consequences of your investment: This applies to all investments, including mutual funds. People invest in Bank FDs and later realize that they have to pay a substantially large amount as tax on accrued interest at the time of filing Income Tax Returns (ITR). Similarly, in mutual funds, different types of funds e.g. equity fund, debt fund, etc. have different taxation. Within equity funds, different options e.g. growth option, IDCW option have different taxation. You should keep the tax consequences in mind and make informed investment decisions. You should consult with your mutual fund distributor or financial advisor if you need help in understanding the tax consequences of your mutual fund investments.
   
   You may like to read: how STP and SWP taxation works


10. Investing without a financial plan: A large number of retail investors in India do not have any financial plan; they invest mostly on an ad-hoc basis. As a result, they end up with wrong financial priorities and are often not disciplined enough about investing. A common mistake is to prioritize short term objectives over long term objectives. At different stages of life, different goals seem relatively more important to us. For example, if you are in your thirties, buying a house may seem to be a very important goal; children’s higher education or retirement planning may not seem important. However, over your life-stage, all the goals are very important. Investors without a well structured financial plan may end falling short of their financial goals. If you are saving and investing without a financial plan, then you should figure out your financial goals and have a financial plan. You can consult with a financial advisor or financial planner, if you need help in making a financial plan. A financial plan will help you to be ready for each financial goal through different life-stages.
    
    Did you know how to invest for your Childrens’ higher education Also how to plan for your retirement?

Conclusion

In this blog post, we have discussed some common mistakes which investors should avoid these when investing in mutual funds. Whether you are investing directly or through a mutual fund distributor, you should know that the onus is ultimately upon you. Our endeavour at Advisorkhoj is to educate you on financial planning and mutual funds, so that you are able to make better financial decisions.