Ritwik Chopra (name changed) started investing in mutual funds on hearing about it from his friends. He asked them to tell him the names of the funds they had invested in and he signed up for SIPs in the same funds. After a few months, he realised some of the funds that he had invested in carried very high risks – way more than his risk-taking abilities and a sudden requirement for funds forced him to liquidate his expenses at a time when the markets were performing badly thus causing him to incur huge losses. The experience left a bitter aftertaste and Ritwik, fearing more losses withdrew his investments from the other funds also.
Such investment stories are sadly not uncommon because these are symptomatic of the most common mistakes made by retail investors especially those who are new to the arena of investing. These mistakes usually fall in the blind spots of investors and can be easily avoided by exercising caution. Here are a few common mistakes that you should avoid as a mutual fund investor.
Investing without goals and time frames
Investing in mutual funds without having a specific goal in mind is pretty much akin to driving around without having any destination in mind. Unless you are clear about your purpose of investing, you will not be able to envisage the amount of capital you want to accumulate through the investment, the amount you would have to invest at regular intervals and the frequency of your investments. Also, investing without a set goal also makes it harder to gauge accurately whether an asset class’s performance is stable enough to generate the returns in the stipulated time frame of your goal because there is no point holding an investment which can derail the attainment of your goal by a few years. Goal-based investing helps you define the risks you can take and goals acts as the signpost to stay disciplined and on-track with your investments.
Lack of research
It is tempting for many of us to simply carry out a copy-paste operation and choose funds based on someone else’s idea of the performances of the fund. However, the problem is that one man’s meat could be another man’s poison. It is important to sidestep the temptation of taking such shortcuts and doing your own research before choosing a fund. Judging a fund simply by looking at the ranking of a mutual fund scheme or its past performance is not enough. As an investor you should ask questions like – what is the nature of the fund (is it equity-heavy or dent-oriented), what is the risk factor, who is the fund manager and what is his/her track record, how has the fund performed during periods of slump, what is the expense ratio? Gathering all this information is crucial to ensure that the fund is right for you before you start investing. Getting carried away by the buzz in the market can prove to be a costly mistake in the long run.
Investing in too many or too few funds
If there is one axiom that all investors should always remember no matter where they are in their investment journey it is that ‘Putting All Your Eggs in One Basket’ is perilous. In the world of investing it simply means that you should avoid putting all your money in a single basket because this makes you overexposed to risks. For instance, consider the situation where an investor has dumped all his/her savings in high-risk equity funds. Now if the markets enter a slippery slope, the chances of losses will amplify and the investor may even up suffering significant losses. Now had the investments would have been spread across different asset classes, the non-equity component of the portfolio would have acted as a shock absorber and diminished the impact.
Alternately, there are many investors who tend to over diversify their portfolio and even that can be a recipe for disaster. Managing too many funds and keeping a tab on the performances of all funds can prove to be a nightmare and you may end up having funds in your portfolio that may not be suitable for your goals and your risk-appetite.
Ignoring inflation in the bigger picture
If you are still learning to tread the waters in the world of investments, you should always bring inflation into the picture when analyzing returns of an investment vehicle. Inflation is pretty much the elephant in the room but it is a cardinal sin to ignore its impacts on investments. This is because inflation causes erosion in the value of money – you would not be able to buy the same amount and quality of goods for ₹100 that you could have bought five years ago because the rupee’s worth then was way more than what it is today and it is going to be even less a few years down the line. In a nutshell, inflation reduces the purchasing power of rupee and this also impacts your investment returns. For example, if you have invested in a fixed deposit that offers a return of 8% and if the prevailing rate of inflation is 5%, your effective returns from the investment would hover around the 3% mark; a figure much lower than what you would have anticipated had you not taken inflation into account. Hence, envisaging the effect of inflation on the returns of your fund is an indispensable exercise because parking your money in an investment which is not able to beat inflation defeats the purpose of investing.
• Goal-based investing helps you define the risks you can take and goals acts as the signpost to stay disciplined and on-track with your investments.
• Gather all the information and research to ensure that the fund is right for you before you start investing. Getting carried away by the buzz in the market can prove to be a costly mistake in the long run.
• Many investors who tend to over diversify their portfolio and even that can be a recipe for disaster. Managing too many funds and keeping a tab on the performances of all funds can prove to be a nightmare.
• Envisaging the effect of inflation on the returns of your fund is an indispensable exercise because parking your money in an investment which is not able to beat inflation defeats the purpose of investing.
Disclaimer: This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund.