6 mistakes to avoid while choosing Mutual Funds for Beginners

If you are thinking about doing investments or already have done some investments, you might have considered Mutual Funds as one of your investment option. Mutual Fund is very popular investment device among the masses. The reasons are simple- It starts with very low capital hence anyone can afford it unlike Real Estate, Gold etc. and it has low risk and has ability to beat inflation which in turn gives a good Corpus in Long term. You might know the right way to choose Mutual Fund. If not, you can read here- “7 Points beginners should keep in mind while choosing Mutual Funds”. But this article is all about how NOT to choose a Mutual Fund. The 6 most common but big mistakes investor do again and again and hence they not able to generate expected returns. You must avoid following 6 mistakes, let’s discuss them in detail-

1. Investing in Mutual Funds without attaching a Goal: Mutual Fund is an investment instrument which is designed to achieve some financial GOAL. This is basic nature and core of any Mutual Fund. Goal can be anything like Higher Education, Marriage fund, Retirement plan, Buying House/Car or any other luxury etc. If you think you don’t have any such Goal and you just want to build wealth, so should you not invest in Mutual Fund? In this case, your Goal is Wealth Building. There must be a Goal before investing in Mutual Fund and that Goal must be of Long Term. Make sure you choose Mutual Fund after you decided your Goal, it is important else there would be lack of discipline in your investment journey.
2. Investing in too many Mutual Funds: Mutual Fund investment is known for its in-built quality of diversification. One Mutual Fund use to have around 50 holdings (and sometime more than that) for diversification and for reducing risk. If you invest in 10-20 mutual funds just because of their shiny and fancy names and complex schemes, it will not serve the purpose. Investing in too many Mutual Funds means you are investing in all listed companies and hence it will give you the returns matching with Index funds or even less than that because too much of diversification. Don’t invest too many Mutual Funds; Invest maximum in 2-3 good funds and before choosing them, give a good time to research and stick to them for Long term.
3. Investing in Sectoral and FoFs: The Sectoral funds are those which invest in one Sector and FoFs are those which invest in some other Funds (usually outside India). The most important reason for NOT investing in these Funds is that- it is not following true diversification which is a basic rule of Mutual Fund. They are concentrated and hence they are risky, retail investor should avoid investing in it. Moreover, any Government policy or set of rules can impact a sector significantly and hence it increases its risk further. You might think that some sectoral funds have given very good returns in past one or two years like IT sector, Pharma sector etc. but the way they have rise, there are chances it can fall with same pace. So in Long term, for retail investors, it is not a good strategy to invest in Sectoral Funds and FoFs.
4. Frequently Selling and Purchasing Mutual Funds: Mutual Funds can give its best performance only when you give it enough TIME (and also money offcourse) for performing. It is a Long Term investment and best out of it can only be taken in Long term. When you sell your Mutual Fund in Panic because everyone is selling in the market and market is going down, you do here 2 mistakes. One, you are selling when its value is going down which actually not the reason you have invested. Second, you are paying Capital Gain Tax which reduces your Corpus and now if you re-invest this reduced Corpus, you loss the Corpus and also its return which you get otherwise. You might think, when market is going Down you should not sell, but what about if market is going Up, you should book profit and invest after the crash. It is not easy, and most of the retail investors can’t time the market. Better way is to stay invested and best way is to keep going your SIPs and relax, it is guaranteed that you will create a Corpus which makes you happy. Follow the popular saying- “If you want to enjoy GREEN stay invested in RED.”
5. Investing with criteria Lower the NAV better the Mutual Fund: Every Mutual Fund has NAV. Net Asset Value. NAV performance is the Mutual Fund performance. The formulae which Fund house use to calculate NAV is– ((Asset – Liabilities)/no. of units). After that Expense ratio is adjusted on every trading day that gives the final NAV. Here Assets are- AUM i.e Asset Under Management means the money collected by Fund house for investment. Liabilities are redemption requests at one particular time on Fund House. No. of Units is a figure of total units which Fund house wants to allocate and it is completely on Fund house to decide this figure. NAV no. can be anything if Fund house changes the No. of units. So absolute NAV figure has nothing to do with Mutual Fund performance, it is important when compared with its own past value (not with any other Mutual Fund). It is same as Stock price; no stock is expensive if its price is high and no Stock is cheap if its price is low. Absolute Stock price of one stock is NOT compared with other stock price. NAV behaves in same way. Check the returns of NAV in different periods of time that can give you the real picture of that Mutual Fund.
6. Investing only in Mutual Funds with Low Expense Ratio: This is last but not the least mistake which is made by most of the investors. The return you see for any Mutual Fund through its NAV has already adjusted the Expense ratio. So you don’t need to deduct it again from the returns. For example– there are 2 Mutual Funds, A and B. A has given 15% annualised return with 0.5% of expense ratio while B has given 16% of returns with 2% of expense ratio. So which is better A or B? If you are thinking A’s net return is 14.5% and B has net return of 14%, so A is better. It is WRONG. The returns are already being adjusted with expense ratio hence B is better for this period of time. You should consider expense ratio as one criterion but you must need to see why expense ratio is too high and how its Fund manager and Fund house is managing it then only you reach to right picture of that Mutual Fund.

Conclusion: If you invest in Mutual Fund, it is important to know- How to choose a Mutual Fund but it is equally important to know- How NOT to choose a Mutual Fund. Avoid these common mistakes that people make while investing in mutual funds, you will enjoy your investment journey in a peaceful manner. Happy Investing.

Finance Tapasvi