In the last few months, I have analyzed the mutual fund portfolios of more than 30 individuals.
And I thought it’s a good idea to share my observations on where people go wrong in mutual fund investing. So, here’s Part 1 of the 2-part series on common mistakes committed by investors.
This is not to be confused with another blog I had penned earlier on mistakes individuals make in managing their money; this one is specific to mutual funds.
Mistake #1: not defining your goals before investing
The No.1 mistake I see is – people get into investing by skipping a few MUST DO steps. They need to answer these before investing:
👉 What are my long term & short term financial goals?
👉 How much will those goals cost me in future, after factoring in inflation?
👉 How much investments do I need to do monthly, from now on to reach those goals?
👉 What is my capacity to take risks?
👉 What should be my asset allocation, consider the above?
Its only once you’ve answered these, that “which mutual fund scheme to invest in” comes into picture. Starting to invest without answering these is like putting the cart before the horse!
Mistake #2: trying to time the market
Many individuals try to “time the market”, reflecting through behaviors like:
👉 Waiting for “right moment” to start investing,
👉 Stopping their investments when the markets go down
What is NOT in our control?
Ans: which way the markets are headed in next 1/3/6/12 months
What we CAN control?
Ans: staying invested for the long run, so that our money reaps the power of compounding, we average out our cost of acquiring & hence higher chance of achieving our financial goals.
Do remember: TIME IN THE MARKET is a far important determinant of wealth creation than TIMING THE MARKET 💡
Mistake #3: having too many funds in your portfolio
I come across many individuals with 20-30 or even higher number of mutual fund schemes in their portfolio.
While its true that diversifying your investments reduces your risks, here are a few things to remember:
👉 Diversification beyond a certain number of schemes doesn’t lead to incremental reduction in risks.
👉 By holding more schemes, you are increasing the burden of tracking them, monitoring any developments that might affect their performance like fund manager changes, regulatory actions etc.
A limited number, say 5-7 schemes can be chosen to represent different market caps (large, mid, small, flex, multi cap etc) & investing styles so that your money is not overly concentrated.
You don’t have to be a collector of mutual funds to achieve your financial goals. Just keep it simple by reducing number of funds in your portfolio.
Mistake #4: choosing Mutual Fund schemes ONLY on the basis of returns
For many investors that I come across, the one & the only criteria which seems to matter is – returns 💹. On a lighter note, this is so similar to our obsession in 1990’s/ early 2000’s with mileage while purchasing a car, as depicted in this hilarious ad.
The belief is that if SCHEME A has given 16% returns versus SCHEME B’s 12%, there’s no way the latter can be better.
There are many problems with chasing returns:
▶ The approach extrapolates future results from past returns, or put it simply – the future will behave like the past has played out. However, this is hardly the case. We constantly see churn in the list of top performing mutual funds across categories. There have been studies which show that there is a more than a 50% chance of the top 3 performing funds in a particular year languishing in the bottom half in the very next year.
▶ There is no consideration to – your overall asset allocation & how the scheme in question fits into that. For instance, if your risk appetite is conservative, then a sector specific fund should have no place in your portfolio, irrespective of their recent returns.
▶ Risk & returns go hand in hand. Fine, you want to invest in the highest performing category/ scheme, but are you ready to take that additional risk that comes attached with it?
A more practical approach would be to select consistently performing funds whose investment style matches your requirements, and which are in line with your financial goals & risk taking capacity.
Mistake #5: investing very small amounts
I recently met someone whose monthly SIP amount of Rs 20,000 seemed too low, considering her seniority in the large organization she worked for.
On probing further, it transpired that she had started with SIP of 20K more than 5 years back, and that hasn’t changed since then, inspite of her financial situation having evolved so much.
Here are a few pointers on WHAT’S THE IDEAL SIP AMOUNT FOR YOU?
▶ The right amount for you is completely a function of your financial goals & the number of years left to reach that goal (another reason why setting financial goals is so critical). So, if you are 30 & want to retire early by 45 years & you haven’t even yet started, your SIP amounts need to be much higher than if you had started at 23.
▶ Keep in mind that mutual funds as compared to other traditional asset classes like PPF, PF, FDs, SSY etc gives you highest delta over inflation & hence your asset allocation for long term wealth generation needs to reflect this.
▶ Keep reviewing the SIP amounts every year to reflect changes in your financial situation.
▶ Build emergency fund to tackle unforeseen events, before you start thinking of investing via SIPs.
So, the next time you are deciding your SIP amounts, keep all of the above in mind.
Mistake#6: believing that MF returns follow a linear path
It is common for most first-time investors to ask how much return they can expect to earn. Lets say, their advisor told them – 12%.
The belief is that the Rs 100 they invested would grow as per this pattern:
👉 Year 1: Rs 112
👉 Year 2: Rs 125 (remember, its compounded returns, hence Rs 125)
👉 Year 3: Rs 140
👉 Year 4: Rs 157
👉 Year 5: Rs 176
However, when the script in real life plays out differently – lets say, the portfolio shrinks to Rs 85 by Year 1, panic strikes 😲
What gets conveniently forgotten is that – your portfolio is subject to market risk. The returns do NOT follow a linear path 💹
At the same time, its also very likely that by end of year 5, in that same scenario, the investment still touches Rs 170 or Rs 180, thereby giving you an annualized return of 12% apprx.
But for that to happen, you need to bear with the roller coaster ride of ups & downs of market investing.
This is one of the most fundamentals lessons of personal finance – higher returns comes with additional risk.
Mistake #7: investing in NFOs with the expectation of quick profit
There is a huge myth among a section of investors which simply put in mathematical terms is
NFO = easy money
How?
There is a belief that since you are putting your money at “just Rs” 10 NAV, there are higher chances of making a quick profit because the NAV just needs to go up “a bit” by Rs 2 or 3 🙄
This misconception needs to be cleared.
The factors supporting a Rs 2 movement for an NFO of Rs 10 are the same as a Rs 20 movement on an existing fund NAV of Rs 100. Both have an equal likelihood of occurring or not occurring.
In fact, one needs to think twice before investing in a NFO because:
➡ No past record: unlike an existing scheme where one can check the past record of returns, portfolio composition & many other relevant data points.
➡ Flavour of the season: most funds are launched to capitalize on some buzzing trend or segment where the returns have been exceptionally high in the recent past. There’s a very high chance that this may normalize in the long run.
Just because there is an NFO accompanied by a lot of noise, doesn’t mean it’s right for you 🤔
Mistake #8: not reviewing the portfolio periodically
While “fill it, shut it, forget it” approach is best recommended for long term wealth creation, one thing one must never forget to do is – periodically reviewing your mutual fund portfolio.
Why is it important?
👉 Ensuring that our portfolio aligns with our goals, risk appetite & your financial situation. Changes in any of these means you need to relook at your portfolio.
👉 Enable rebalancing of your asset allocation to remain close to the one appropriate for you.
👉 Evaluating your schemes’ performances against their respective benchmarks so that you can weed out consistently under performing funds.
Its similar to doing the annual spring cleaning of your wardrobe closet!
How often to do this exercise?
Once or max 2 times a year. For sure, one must not fall into the trap of doing too frequent reviews & taking momentary decisions just on the basis of recent short-term data.
Hope you found this useful. Do share with anyone in your circle for whom this could be relevant. Watch out for Part 2 of this series on common mutual fund investing mistakes.
