It’s no news that investments in mutual funds are some of the most common and trusted investment options out there, and for a good reason. But with anything that involves money, one should be extra careful, and the same applies to mutual fund investments. Avoid these common mistakes to get the best out of your investments.
In this article
About Mutual Funds
If you have saved up some money of late and are looking to invest them in mutual funds, congratulations! Smart move on your part. Or even if you are alien to investing and would like to know the risk associated with mutual funds investing, stick with us. You’ll be much more knowledgeable about the topic at the end of this article.
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Mutual Funds refers to a pool of money, accumulated many investors like yourself, being invested in stocks, bonds, and securities.
The feature of mutual funds is that unlike other investment options, a mutual fund investor does not need to buy, manage and sell individual stocks or bonds. This process is handled in the background by mutual fund companies.
This ease of management and risk-sharing aspect of mutual funds makes it an attractive option for newbies and seasoned investors alike.
Alright, now let’s about the biggest mistakes investors make while investing in mutual funds and how you can avoid them.
This might seem like a no-brainer. You’d be surprised to know the number of cases we receive of people investing in the wrong fund. And later realising it conflicts their needs. So please do not make this mistake.
Before you begin, be sure it is mutual fund you want to invest in. Though they are a great option for most people, don’t be pulled into it because you heard your friends talk about it. Your needs and requirements may be different from them. There’s little point in investing in funds which do not provide you with peace of mind.
Now that we have covered the essentials, let’s look into the specific mistakes that should avoid while investing.
2. The Expense Ratio
When you invest your hard earned money in a mutual fund portfolio, the entire amount is not spent as an investment. There is a portion of that amount that is paid as a fee to the mutual fund management company. This portion is called the mutual fund expense ratio.
The expense ratio for different companies is different. The companies wouldn’t flinch before racking in a more-than-fair cut out as their fee. The result of this, even two very similar investment portfolios could vary vastly in the level of wealth for you, the investor.
How to Avoid: When comparing portfolios or funds on Groww, check the expense ratio of similar funds.
3. The Scheme Information Document
You should probably take the prospectus of your mutual fund more seriously. Not only does it give you important information about the fund, but also highlights the terms and conditions.
The important things the SID highlights are:
- Fund’s Holdings: This refers to the details of what your funds own and the diversification of assets.
- Fund’s Limitations: Most mutual fund managers follow a single style or methodology while investing. All the investment from that manager may be directed to a particular region or industry. The SID should give the details about what your funds can own and what they can’t.
4. Risk Mitigation
Risk mitigation refers to the process of diversification of the resource allocation to minimise the overall risk. In English? Do not put all your money in one fund, no matter how promising it looks at that time.
You shouldn’t only concentrate on funds which are well performing at that point in time.
We understand how tempting the prospect of hitting a big home-run with a fund is, but take it with a grain of salt. There’s also the unfortunate possibility of that investment hitting a low point.
5. Bull and Bear
No, we’re not talking about investing in zoos. Bull and bear refers to the different states or performance phases of the market.
The bull phase refers to the time when the market is performing positively and maybe above the average for predicted performance. Conversely, the bear phase refers to the time in the market when it is performing negatively and below the expected performance.
Also called market conditions, these factors play an important role in investments and the behaviour of investors. Talking about dealing with market conditions is a dangerous thing to do because the outcome of a decision is as uncertain as the market itself.
So is there nothing you can do? Of course, there is. It is very important that you change and modify your investment options according to the market conditions. But the key here is moderation.
Do not make any drastic change to your mutual fund investment plan merely looking at the present market state. The last thing you’d want is your favourite fund going in the red zone. Or that poorly performing fund that you took your money out of is performing well now. See what we mean? Again, moderation is your ally.
6. Capital Gains Tax
That’s right, taxes. Mutual fund incomes come with accompanying taxes. They are called Capital Gains Taxes.
The capital gain that a mutual fund generates by the sales of shares of stocks are paid out annually as distribution to the investors (that being you). And these distributions are taxable. The higher the turnover rate of your mutual funds, higher the taxes.
You should be careful and aware of these taxes as these taxes could negate the benefits of owning the mutual fund.
You may also want to look into the ways of minimising or avoiding these taxes.
7. Target Setting
Instead of shooting through the skies with your expectations, it is wise to be realistic.
Being unrealistic not only invokes unhealthy risk-taking but may also result in steering you away from mutual funds which are quite profitable.
So, do not enter mutual funds with near-impossible expectations. Instead, plan for average returns and proceed with your investment process in a planned manner. Researching past returns of mutual funds will help you understand the kind of returns you should aim for. If you do manage to get that crazy 100% return, be careful while making further decisions about increasing your investments or withdrawing it. Give it some time to see how it changes.
There are many other aspects of mutual fund investing that investors should be careful about. Let’s run through them quickly.
- Open-End or Closed-End: Find out whether your mutual fund is the open-ended or close-ended. A closed-end fund is much more limiting as it has a set number of outstanding shares and it operates for a fixed duration of time.These are much like trading in stocks. An open-end fund, on the other hand, is available at all times and offers full flexibility to the investors. The majority of mutual funds are open-end anyway.
- Profit Booking: There are many myths surrounding profit booking of mutual funds and their recommended time and regularity. In the end, it all comes down to your preferences and investment goals.If you have achieved your goals, there’s no reason for you to not book your profits. But you should also not go overboard with profit booking as it reduces your chances of making significant long-term earnings.
- Stopping SIP: Another controversial topic, the decisions relating to your SIPs should be taken with a lot of thought and not in the spur of the current market conditions.
- Experts and Pundits: Yes, they’re everywhere. And no you should not always listen to them blindly. First of all, the majority of people throwing advice at you don’t know all that much about the market and its ways as much as they claim to do. Even if somebody is offering a genuine piece of advice, it does not hurt researching about it before taking some drastic action.
- Don’t Rest Yet: Yes, it’s great that you made a good deal of profits, but your job isn’t over yet. Don’t hit the couch just yet. Continue monitoring the progress of the funds and the market and explore options of modifying your investment plan to generate even bigger gains in the future. But again, as it is with everything related to the market, don’t get too carried away.
Investing in mutual funds is one of the best ways of putting your idle income to good use and making some cash in the process. And as long as you keep focus and be careful about the possible blunders we talked about, there’s no reason you shouldn’t earn good profits. We have repeated this many times over in this article, but we’ll do it again, just to steel in you its importance: Be patient, do not get discouraged by temporary low times or be carried away by momentary high points.