‘Mutual Fund Investments are subject to market risk please read the information document carefully before Investing’ goes the oft-repeated statement. Like the warnings on cigarette packets, investors tend to ignore this caution. But this is very important to understand the mistakes that you might make while investing in the Mutual fund:-
1. No clear understanding of risk appetite
Many of us get carried away by the returns of two or three Mutual funds schemes or from any tips from Friends and Family without understanding the risk that we can take. We don’t check about funds performance, the proportion of large cap, small cap and mid cap that a Fund is investing into, Companies in which Investments of Mutual fund is made. Ohh Yeah! That’s technical but these things need to be checked as there’s hard earned money involved.
2. Unaware of mutual fund charges
Mutual fund charges fees when you redeem your money. There are also other “operating fees”. This is a percentage of what it costs to run the fund. Lets say you invested Rs.10000 and operating fees are 2%. This means that you are effectively paying Rs.200 every year in operating charges.
3. Investment with high expectation in returns
Basically while selecting Mutual fund investors choose investments with an expectation of unreasonable (40-50%) returns. This is not going to happen, and in an attempt to generate that return, we are likely to be misled into funds that have shown a temporary blip in performance. Always look at returns over a minimum 5 year period.
4. Investing without understanding underlying Investments
Many of us get carried away for Investing in MFs either by starting a SIP or Investing into Lumpsum without understanding the fact there are several mutual funds with different asset classes and with different type of behaviors which offer different returns. Debt funds provide lower but steadier return. Equity funds provide higher but more volatile return.
5. Investing in Dividends
We often see an advertisement by mutual funds declaring dividends and tend to believe that higher dividends reflect good performance and thus we are misled. In case of mutual funds dividend declaration is nothing but a mere book entry. Dividends are not interest but repayment of capital. Therefore the fund’s NAV falls to the extent the dividends are paid out to its unitholders. In fact, a growth option where you withdraw the money when YOU need it is better from the tax perspective.
6. Investing without comparing with its benchmark
While looking at a fund’s performance, Don’t look at the fund’s return in isolation. A scheme may have generated 8% annualized return in the last 24 months, but then even the market indices are strolling around that figure. Underperformance in a falling market, i.e., when the NAV of the fund falls more than its benchmark (or the market), could still be a reason to review your Investment. Therefore, compare the scheme’s return as against its benchmark return.
Yes, quite a few of Investors do above small mistakes because of which they are not able to generate better returns. However following things need to be kept in mind while selecting a mutual fund:
1. Choose the category of funds from Debt, Equity or Hybrid. Within that category, the right scheme can be chosen based on criteria such as past performance, comparison with peer set and benchmark.
2. Try to identify fund houses that have a strong presence in the financial world and provide funds that have a reasonably long and CONSISTENT track record.
3. Have a look at a Mutual fund that is diversified into the different asset class, stocks, sectors, and even geographies. A diversified portfolio has lower risk than a portfolio biased towards the particular stock, an asset class or a sector.
An understanding of market risk is important, but if you have chosen the asset class that best meets your objectives, you can trust the fund manager while managing the investments for you. As an Investor, you should focus on things you can control which are:
1. Choosing the right mutual funds
2. Following the correct process of Investing
3. Reviewing your Investments every year
Risk management applies to both to fund houses as well as to Investor. In both cases ‘4T’ risk criteria applies as below:
Treat the risk; Transfer the risk; Take the risk; Terminate the risk.