5 Common Mistakes Mutual Fund Investors Should Avoid

November 16, 2022 Mutual Fund

Having the right investments is essential for every individual to ensure a sound investment portfolio that can earn maximum returns and increase wealth. Investors today have a wide range of investment options. With diverse opportunities, mutual funds have gained popularity as an investment choice, making them an ideal tool for creating a solid investment portfolio and achieving financial goals. The majority of people either invest in mutual funds themselves or know someone who does.

There is something for every type of investor, given the variety of mutual funds available in the market. You may be sure to find a mutual fund strategy that satisfies your unique investment goals, regardless of whether you are a risk-taker or risk-averse investor, want to invest for the short, medium, or long term, want to reduce taxes or want to create wealth.

Consequently, more people are jumping on the bandwagon daily and investing their hard-earned money in this investment vehicle. One of the critical reasons for this popularity is that mutual funds offer the opportunity to diversify and, therefore, spread out their risk over a number of investments. You could be one of those curious about investing in mutual funds; maybe you have heard a few things from your friends or relatives and want to learn more before jumping into mutual funds.

Contrary to popular belief, while you might assume that most individuals are familiar with mutual fund investing, it’s not so. When it comes to investing in mutual funds, people make mistakes since there are risks involved; therefore, you should exercise caution when participating in any scheme. This article elucidates the few mistakes that investors make so that you don’t repeat them.

In order to make sure that you, the investor, get the best investment options in your kitty, there are certain common mistakes that have to be avoided. However, whether you are a novice or a veteran investor, there are certain common mutual fund mistakes that you must avoid while investing in mutual funds. Here are 5 of them:

Mistake #1 – Investing Without a Definite Goal

Every mutual fund has a distinct investment goal. Some mutual funds might be appropriate for long-term investments, while others might be appropriate for short-term goals. Similarly, certain funds may have an investment strategy, like equity mutual funds may give you the opportunity to focus on wealth creation, while some may focus on tax saving and others, like debt funds, may give you fixed returns.

Defining your financial goals clearly is crucial before choosing your mutual fund scheme. The objective can vary from saving taxes, buying a home after a specified period, retirement plan, child education, etc. Defining and mapping out a precise goal before investing in mutual funds will help you figure out the duration and decide how much money you should put in and in which scheme. If you invest without any goal, your financial goals may remain unfulfilled.

Mistake #2 – Unrealistic Expectations

If you invest in mutual funds, you must create a portfolio after considering the risk of market fluctuations and expect realistic returns. If you are a first-time investor, you might end up having high expectations from the schemes you invest in. Mutual funds undoubtedly have the ability to offer you sizable profits, but you must be aware of market volatility and have a thorough understanding of long-term trends. This is because future market performance cannot be predicted precisely due to shifting economic, social, political, and company-specific factors.

Also, chasing only the past performance of funds is not a wise move, as the past performance of funds is not the only indicator of the funds’ future returns. The slightest fluctuation in the returns can often drive investors away from quality investments or can make them liquidate their assets for short-term gains. This often leads to them missing out on the long-term benefits of staying invested for longer durations. Long-term wealth creation requires investors to grasp the importance of patience and allow their investments to grow.

Mistake #3 – Lack of Research

With multiple mutual fund options available in the market, it is always a good idea to do appropriate research before picking one. Many investors do not consider doing thorough research and simply search for ‘best mutual funds’ online. But is that the right way to select a fund? We do not think so.

Also, it is equally important to know the fund type, exit load, historical returns, asset size, expense ratio, etc., along with having a fair idea about your risk-return profile before investing your hard-earned money in any mutual fund scheme. It is always better to use authenticated resources to study and research the funds that you plan on investing in, like the Scheme Information Document (SID) and the qualitative or quantitative factors related to the scheme. Additionally, you may consider consulting the experts who follow a stringent research process that assist you to invest in worthy mutual fund schemes. I recommend that you subscribe to PersonalFN’s unbiased premium research service, FundSelect.

Mistake #4 – Over Diversifying Your Portfolio

There’s no doubt that diversification and spreading your investment is an essential step as it reduces the portfolio’s overall risk. But that doesn’t mean that over-diversifying your profile is the way to go. In order to mitigate risk through diversification, many people invest in too many funds. However, having a large number of funds increases the chances of having many underperforming funds in your portfolio, and investing in too many funds will not ensure high returns.

As mentioned above, diversification is essential for a sound portfolio. However, there is a fine line between diversification with suitable asset allocation and over-diversification. Investors should not invest in multiple investments of similar nature just in the name of diversification. For example, if the investor invests in large-cap funds, a maximum of 2-3 funds in this category is enough to generate good returns. Investing in 5 or 6 large-cap funds makes no sense as they will have more or less the same underlying equity stocks. Over-diversification in such cases will only increase the cost of investment and dilute the net returns of the investor.

Mistake #5 – Not monitoring your portfolio periodically

You need to review the performance of your portfolio timely to keep them aligned with your financial goals. Markets are volatile in nature, and various macroeconomic factors influence the market’s performance and create fluctuations in returns. The fall in equity portfolio value during the volatile markets, along with the negative news flow, adds to the anxiety of an investor. Remember, based on current market trends, spur-of-the-moment decisions can prove very costly.

The periodic evaluation of your mutual fund holdings is essential to monitor the health of your portfolio and ensure its not carrying funds that are underperforming well over a prolonged period of time or funds that may be exposed to some kind of risk in the current market. When your portfolio is shrinking, it’s preferable not to think about new strategies. Instead, perform a portfolio review and analyse your assets using a variety of quantitative and qualitative parameters. If necessary, you can rebalance your portfolio. You may consider having a year-end portfolio review as the year 2022 is about to end.

You see, these are the most common mistakes that investors make; despite these facts, there are still a plethora of errors that you may tend to make while investing in mutual funds. Do note like any other investment vehicle, mutual funds also include some degree of risk. It is crucial to first evaluate your own risk appetite and have a long-term investment approach to generate better risk-adjusted inflation-beating returns. Each mutual fund comes with a riskometer that tells you how risky the investment option is. Knowing and understanding the scheme riskometer lets you analyse your risk tolerance before making an investment decision.

Apart from that, you must avoid taking impulsive decisions under the influence of somebody you know or without understanding or having complete knowledge about the fund. Also, liquidating or panic selling your mutual fund units should definitely be avoided in case of a market crash. Thus, it is important for you to stay relaxed during market corrections and monitor the funds’ performance to make informed decisions.

To conclude…

The persistent repercussions of geopolitical tensions, slow economic growth, increased uncertainty and the ongoing sharp interest rate hikes around the globe with a degree of coherence unseen over the past five decades to curb the spiralling inflation and warning signs of high market volatility in the near term are flashing in the global economy. Investors have been avoiding risk assets due to a confluence of such intertwining factors. The fact that markets have been volatile has weakened investor sentiment.

Given the headwinds in play, you may make some costly investing mistakes. When markets fall sharply, it’s normal for investors to panic. However, as per historical data, markets have always plummeted in past in reaction to such situations – be it wars, pandemics, terrorist attacks, financial crisis, scams, or others- and then recovered eventually. Therefore, if you are planning to invest in mutual funds in the prevailing market conditions, it’s better to be wary of these common investment mistakes. That way, you can ensure that you avoid these pitfalls and make the most of your mutual fund investments.

This article first appeared on PersonalFN here