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Mutual Funds Common Investing Mistakes To Avoid

Apr 6, 2016 by Pradip Chakrabarty | 116 Downloaded
Picture courtesy - PICJUMBO

We at Advisorkhoj receive queries regularly about investing in Mutual Funds. Most of the queries are very basic and relate to what is the best time to start a SIP or should one stop the SIP when markets are not good. Some queries pertain to investment in various category of funds, like – Why not invest in sectoral or small cap funds (as their past performance is quite attractive) in lieu of Diversified Equity Funds or Large Cap Funds. Some readers have written and call us regularly if they should start SIPs in schemes with large corpus as they doubt that the current performance may or may not be sustainable in future due to the size of the fund. Investors feel that smaller funds are more flexible and thus can churn better returns. We devote lot of time and energy replying to each one of these queries in order to help investors clear doubts about Mutual Fund investing from their minds and help them take the right decision to have a better financial future.

We feel Mutual Funds are simple investment products and best for long term wealth creation yet we find that investors track stock market movement and take hasty decisions about their Mutual Fund investments. We notice that mostly ELSS investments are done at the end of the financial year, more investments are made at the peak of the market and most redemptions are done when markets are not doing good, Sticking to schemes not doing good in anticipation that it will do good in future, is another common mistake. Investors tend to follow herd mentality and thus make investments based on so called hot tips. These are some of the common investing mistakes and therefore, we thought of doing this article based on different type of queries received in order to further clear the doubts for our existing and new readers.

Lets us now see what these common mistakes are and what one should do or do not.

Do not stop SIPs when markets are uncertain

Wealth creation by investing through Systematic Investment Plan route is a proven fact. But how many investors could create wealth in the long term? We find that large number of SIPs get closed when markets fall. It is a fact that the investors think long term when they start SIPs but get unnerved with little fluctuation and start thinking short term and stop it as they feel that the market will go down further. In fact, volatility is good for their long term investments as they benefit from rupee cost averaging. You accumulate more units when the markets are down and less when it is up. SIP is nothing but a disciplined way of investing in equities for long term wealth creation. Therefore, tag your existing SIPs with your future financial goals, like – Retirement planning, higher education of your kids or a world tour and track them. Once you tag your SIPs with your goals you need not redeem them, just keep investing and enjoy the investing journey till such time you achieve your goals.

Do not redeem equity mutual funds when in emergency

The first thing investors do when they need funds due to an emergency is to redeem their equity mutual funds. Mutual Funds are for long term, and therefore, should not be redeemed before you get the desired returns or your goal is achieved. But, how to get money in case of an emergency situation? It is simple - build an emergency corpus fund. The way you are building your long term wealth by investing in equity mutual funds, build the emergency corpus by investing in liquid or short term debt funds the same way. In fact, while starting a SIP in equity mutual fund, you should also start a SIP in a liquid fund or short term debt fund. Returns from liquid funds vary between 7-8% and can be redeemed without exit load in T+1 day. That means, if you redeem the fund today, you will get the credit in your bank account tomorrow, provided it is a working day.

Do not try to time the market

Investors tend to hold their investments waiting for an opportune time to start their Mutual Fund investments. This opportune time is nothing but the levels of the market. For an Investor the Sensex level of 24,000 may not be the right level to start as he feels that the market may go down further while another investor feels that 30,000 levels is a good time to start as he feels that markets will go far off in the future.

How to avoid this? It is very difficult to answer as this has less to do with investing and more relate to the behaviour of the investors. When it comes to investing, that too equity investing, investors are not as rational as they think they are. Majority of the Investors get optimistic when the markets are on upward move or doing well and assume that it will continue to do so. On the other hand, many investors become extremely pessimistic during volatile periods. Investors tend to place too much importance on current market events while ignoring past performance of equity as an asset class. Also, investors show a different degree of emotion towards profits or gains than towards the investment losses. They are emotionally more stressed by prospective or booked losses than they are happy from profit or gains.

The question is how to handle these emotions? In reality it is impossible to time the stock market and thus there is no sure shot way to “buy low and sell high”. The best way to ride the volatility is to invest in a discipline manner by investing regularly. The other way to arrest the volatility is to invest according to your asset allocation, based on your needs, risk taking ability and by linking the investments with your future goal.

Let us now understand this by examples –

If your risk profile indicates that 50% of your investment should be in equities than you must consider an investment horizon of 5 years atleast. You should invest your monthly surplus through SIPs and link this to one of your long term goals. In case you also have lumpsum amount in your hand then you may put it in a liquid fund and do a weekly STP to an equity fund for the long term. This will ensure that you are not investing all your money in one go and ensuring maximum averaging by investing weekly. On the other hand you earn superior returns than your savings bank account by investing in liquid funds.

For the rest 50% investment (which you can not keep in equities due to your risk profile) you may keep a part of it in liquid funds to meet any emergency fund requirement. Another part can be kept in long term debt funds with a view of 1-3 years or Capital protection funds. In case markets remain choppy and do not generate any positive return during these three years, you will still have positive returns from your debt, liquid and capital protection funds. Needless to mention, your equity investment will continue to acquire more units at lower prices during this period and shall earn much superior returns when the markets start doing good.

The above simple solutions, if followed, will ensure that you spend more time in the market than timing the market.

Do not hold too many Mutual Fund schemes

One of our callers from Kanpur selected 7 schemes for doing a monthly SIP of 14,000. I could make out that he has chosen one equity fund each from 7 categories and selected the top performing fund from the respective category based on 5 years return. What the investor failed to understand is that each category has a different objective which may or may not match with his risk profile. Moreover, over diversification does not mean more return or less risk. In fact, it can be more risky and possibly generate lesser returns.

Investing in too many schemes is most of the time overlapping of investments in the same kind of portfolio or companies. Investing in same stocks through different schemes is meaningless. Moreover, if you keep more schemes then tracking their respective performances could be cumbersome and may take more time.

Mutual Fund invests in diversified portfolios of equities and debt etc. Therefore, the investor should choose a fund from a category which is best suited to his risk profile. For example – a young investor can put entire money in equity funds and choose to invest in small and midcap funds. A person with medium risk profile may choose to invest in Balanced Fund and a conservative investor might invest in debt funds only. So once you know your risk profile, you should choose 1 -2 funds from each category and invest. Generally speaking, if you are investing in equity mutual funds and want peace of mind than Diversified Equity Funds are the best investment option. If you can select one or two good diversified equity schemes your investing objective will be fulfilled.

You may like to check this Calculator https://www.advisorkhoj.com/tools-and-calculators/asset-allocation to assess your risk profile.

Do not hold under performing schemes

Investing in Mutual Funds may be simple but selecting a good fund and monitor the performance of the fund may not be that easy. To get the maximum return or also to know if your chosen scheme is performing in line with its peer group, it is suggested that you review your mutual fund portfolio atleast once every year. Based on our experience we find that investors hold on to the underperforming schemes with the hope that it will start performing when the markets recover. But most of the time it may not be the case.

To monitor your mutual fund scheme’s performance you should check if the scheme is continuously beating the benchmark and also how it is doing in comparison to its peers. Do not get emotional with your investments. Check the performance atleast once every year and replace it with a good scheme if it is not performing well.

Conclusion

Based on our real experience we have done this article. Throughout the article we tried explaining the benefits of investing through SIPs, how asset allocation and setting goal is the most important aspect of equity investing, how one should not get carried away with ones investment and how to overcome some investing behaviours in order to get the desired returns from your investments with much less efforts and no stress. Unfortunately, in our country, equity investing is hugely influenced by common mistakes and myths. We will try to help you overcome some more investing mistakes in the second and concluding part of this article tomorrow. Look forward for your comments and feedback.

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Pradip Chakrabarty

Pradip is a first generation entrepreneur who has built a very successful business for distribution of financial products over last 19 yrs. He is also the Founder and CEO of www.advisorkhoj.com. Pradip is well respected in the Financial Services industry and brings deep domain knowledge and leadership skills and is considered as one of the top Investment Advisors in India. He can be contacted at pradip@advisorkhoj.com

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