Do's & Don'ts to get more from your Mutual Funds Investments

Golden lessons to get more from your Mutual Funds Investments

There are several inherent benefits of investing in Mutual Funds. Mutual Funds most important advantage is diversification of investment at a fraction of cost than could have been required be possible for you as an individual investor 

If you check returns of a good rated fund, you will probably discover that their annualized returns or CAGR had outperformed other asset classes by a quite margin.

Systematic Investment Planning or popularly known as SIP help an investor to start with very small amounts of money as in this option as low as ₹ 100. Investors can start investing even when they don't have a lump sum amount for investing. SIPs are called as ideal way to achieve retirement goals for investors. This sounds simple and a no brainer. So all SIP / Mutual Fund investors achieve this goal? Unfortunately NOT.

Here are certain golden lessons OR Do’s and Don’ts for investments in mutual funds. These lessons or Do’s and Don’ts will help

DO’s

Understand how Mutual Fund works

Most of the time when investors migrate to SIP from guaranteed return assets like Fixed Deposits and PPF, they do so with insufficient understanding of how mutual fund really works. Most often investment is made after reading past returns of 12-14% in immediate 1-2 years.  One must understand that unlike FDs, returns in mutual funds are non-linear in nature. Some mutual fund investment particularly thru SIP can yield negative returns in initial period (from few months to few years) but then picture may change completely in next few years and returns can become double digits returns on a compound annualized basis within months!

Compounding is called as 8th wonder of the world. But to fully realize its potential high level of conviction and patience is needed. So if you can’t stand phase of no/negative returns it’s better to stick to investment of guaranteed nature such as PPF or NSC which are backed by sovereign guarantee.

You can read of article on National Saving Certificate

Have realistic goals

As mentioned above, often investment in certain mutual fund is made solely looking at its past performance of couple of years.  In rising markets, mutual funds have delivered over 100% returns in some years. Investors must note that if it was so easy then everyone would be millionaire. The returns in mutual funds are linked to underline equity market which can be extremely volatile. Equity mutual funds can deliver returns in range of 12-15% when one remains invested for a longer period of 5-8 years. Now this is almost double returns than FDs and PF. But we must remember than in this period isn’t fixed and in periods of down market one must be committed to remain invested for long and have reasonable expectation

Research before investing

Today, we have plethora of option to do unbiased research on mutual funds. We can see all details like the vintage of fund, track record of fund managers (for all scheme he/she manage), past returns, comparison with benchmark etc etc. But many a times, mutual fund investment is done on basis of what our friend or colleague as bought rather than doing own research. This is very bad for your investment. If you don’t have time for research, you can consult your mutual fund advisor. Today fee for an advisor usually ranges from as low as 0.30% to 0.8%. But for this you get advise that can go in long way in your quest towards wealth maximization

Select Fund with proven track record

Sometimes, we do hear that a NFO in which unit price is ₹ 10 is better than a fund with unit price of ₹100. You will hear people saying that they got 10x times more unit in NFO than they would have got in fund with ₹ 100/unit. Now this is entirely rubbish assessment. For starters your net investment remains the same in both scenarios. Secondly for 2nd fund, you have history of performance due to which its unit price has become ₹100. So instead of a Fund with proven track record, why would you go with an NFO with no history? We are not against NFOs, but the NFO should offer some different theme, than the funds which are already available. Otherwise the NFO would be a “Me Too” offering.

Invest thru SIP

SIP is a wonderful tool for common investors who wish to build long term wealth. In SIP, one need not commit huge sum of money rather can start as low as Rs 100. This way it also inculcate habit of forced saving as money need to be saved for SIP amount. Read our detailed article on systematic investment plan here. SIP route can be effectively used to counter need of timing the market. Rupee cost averaging can be achieved thru SIP route. SIP is one of the greatest tools available for a common investor.  

Invest according to your risk profile

There are various types of mutual funds. We can categorize funds as ‘Large Cap’, ‘Mid Cap’, and ‘Small Cap’ etc. Risk profile of each of this class of fund is different. Small & Mid cap usually give better returns than large cap. But then it also means, they will have greater volatility. Not everyone can digest such volatility. Let’s take example of DSP Midcap Fund. This is one of the better performing funds who is around since 2006. For last 7 years it has given a good return of 20.135 on a CAGR basis. Since its launch, it has delivered 14%+ rolling returns. This is fantastic performance by any yardstick. But do you know, this fund lost a whopping 60% in year 2008-2009, 60%. It had lost 20% in one week alone (15th Jan 2008 – 22 Jan 2008). So investors who couldn’t tolerate such loss would have moved out back then and couldn’t gain from its performance since.  So while fund was good, it wasn’t commensurate with risk profile of a conservative investor.

Rebalance wherever necessary

We all have heard this line on TV commercial or on radio, “mutual fund investments are subject to mark risk” right? So even though we have done our research, we have done risk profiling, it’s still possible that our investments doesn’t grow as per our planning. e.g. IT companies in India have demonstrated their abilities on global stage. But what if tomorrow, rupee strengthen and become, let’s assume ₹ 50 per USD. This will severely affect profitability of IT companies and in turn share prices may correct. So if you have invested in thematic mutual fund focusing on IT, you may have to rethink of investment despite amazing track record of these funds in past. We must rebalance of investment in rational manner whenever necessary.

Now let’s see, what mistakes one should avoid in mutual fund investments

DON’Ts

Don’t invest just because your peers have

Each individual has his own priorities. Someone may want to buy a car in next 3-5 years, someone wish to invest for his child education or some investments are made for building long term wealth. In each of these scenarios, fund selection would differ. A person with no immediate need and long term goal may go for small/mid cap while someone with a goal of 3-5 years would go for large cap. So one shouldn’t just invest because your peers have but rather, investment decision should be driven by financial goals and investment horizon  

Don’t overdo your research

While research is a MUST for any investment, one shouldn’t overdo the same. Most investors in mutual funds are SIP investors. For these investors, time in market / SIP is more critical than timing the market. Today, plethora of information is available at fingertips. But investors shouldn’t get swayed by it. Tracking performance on a day to day basis will be counterproductive.

Performance isn’t everything

Read example given in point 6 above. Even though performance was good, for a faint hearted investor a 60% fall would mean, return to FDs as investments. So such investors would have done this at whopping 60% loss and then must have missed the spectacular return the fund gave later. So along with performance, ability to align with risk the fund offer is equally important. Also if someone has short term goals, then large cap would be better choice then mid caps even though later have higher return potential     

Don’t invest in too many funds             

Diversification is one of the most important features of a mutual fund. A mutual fund usually invests in 50-75 companies. This offer diversification as losses in some stocks will be compensated by gains from others. The aim of diversification is to spread risk. But we must remember than when we invest in a mutual fund, we are indirectly investing in 50-75 companies anyways. This means owing a mutual fund is diversification in itself. Hence one shouldn’t invest in too many mutual funds as this means investing in same companies. According to SEBI, top 100 companies by market cap are called “Large Caps”. This means as a large cap fund, the options are limited and owning too many large cap funds means duplication for sure. The chances of overlap of ownership of shares are lower in the case of mid /small cap mutual funds simply because the number of mid cap companies is much higher.