10 Common Mistakes that Mutual Fund Investors Commit

Mutual fund investments are, by default diversified. So they address the basic problem of concentration that you face in direct equity investments. However, selection of funds, monitoring and rebalancing still poses a major challenge to investors. Here are the 10 mistakes that mutual fund investors need to consciously avoid.

10 mistakes that most mutual fund investors must avoid

1. Expecting guaranteed returns on mutual funds is the cardinal blunder. Mutual funds are not assured return products. The returns that the fund earned in the last 5 years is just indicative and not suggesting of what it can earn in the future. This applies to equity funds and also to debt funds. In the last few months, investors have realized the hard way that debt funds and Fixed Maturity Plans can be awfully risky if asset selection is bad.

2. Buying mutual funds just because the NAV is low. NAV is unlike the stock price because it just reflects the unit value of the underlying portfolio. Whether you buy the fund at a NAV of Rs.90 or Rs.8 does not matter as much as the quality of the portfolio of the fund. There is no empirical rule to tell you that low NAV funds outperform other funds over a period of time.

3. Comparing two funds purely on returns is another common mistake. A fund that earns 18% is not necessarily better than another fund that has generated 16% because the fund earning 18% may have taken higher risk. Which is better; an 18% return on a fund with 50% standard deviation or a 15% return with 10% standard deviation? That should answer the question.

4. A common mistake is to buy funds randomly. The basic rule is to stick to your long term plans and buy funds that fit into your long term goals. For example, you can have an equity fund to meet a goal that matures after 10 years but equity fund may not work if your goal is maturing in 3 years. In such cases, a debt fund or liquid fund may work better. Instead of buying funds randomly, pin them to specific goals.

5. Another common mistake is to expect mutual funds to deliver multi-baggers. For example, an equity fund may deliver 13-14% annualized if held for a longer period of 7-8 years. But expecting 20% returns on a fund on a consistent basis is being too optimistic. Stocks like Havells, Wipro and Eicher may have been multi-baggers in the market, but diversified mutual funds cannot deliver that kind of returns. For that you need to run concentration risk. You also need to be mentally prepared to take on that risk.

6. When you buy mutual funds, the purpose is to diversify. That is the core idea for mutual fund investments. If you start buying sector funds like IT funds or Banking funds, then you are concentrating your risk. Even thematic funds like commodity funds or mid-cap funds have too much concentration risk. When you invest in mutual funds, your focus must be on diversified large cap funds, index funds or on multi cap funds.

7. Don’t just consider pre-tax returns. What you get on hand is post tax returns. Look at returns after considering capital gains / dividend tax etc. Returns are best judged in post-tax terms. For example, your equity fund is subjected to 15% STCG tax and 10% LTCG tax (above Rs.1 lakh). When you are pegging goals, focus on post-tax returns.

8. A common mistake is plumping for dividend plans, especially when people invest in debt funds for regular income. Dividends are tax-inefficient. For example, a typical debt fund deducts dividend distribution tax (DDT) of 29.12% (including cess and surcharge) on dividends paid out. That is a huge part of your returns sliced off. It is better to opt for a growth plan and structure an SWP.

9. Investing all the money in one shot is another mutual fund mistake. Always adopt a phased approach because that helps you get a better price and reduces your cost. A better way is to structure a passive SIP so that you don’t worry about timing your purchase. Fix a SIP date and stick to it with discipline. It has proven to be a lot more productive in the long run.

10. Not reviewing and rebalancing your mutual fund portfolio is another common mistake. There are various reasons why you need to review. Your risk appetite may have changed, your liabilities may have reduced or there may be a new member in your family. Alternatively, market conditions may have changed. The idea is to regularly review and rebalance.