Common mutual fund investment mistakes that should be avoided by investors are inadequate research, emotional reactions, lack of portfolio diversification, absence of clear goals, misunderstanding risk tolerance, focusing solely on short-term gains, and neglecting fee considerations.
Investing in mutual funds can be beneficial in many ways. You can diversify your portfolio across asset classes, meet various short-term and long-term goals and even enjoy tax benefits. However, most beginners fall prey to common mutual fund investment mistakes that may have significant and costly repercussions.
In this article, we cover the top mistakes to avoid while investing in mutual funds so you can tap into the rewarding aspects of this investment category.
Top mistakes investors make while investing in mutual funds
Whether you are planning to start investing in mutual funds or you already have some of these funds in your portfolio, there are some universally common mutual fund mistakes you should be aware of. Check out what these are and how you can avoid them.
1. Focusing only on performance
Fund performance is undoubtedly an important factor to consider when you are choosing mutual funds. However, focusing on performance alone when choosing mutual funds can be a costly mistake. This is because historical performance is no guarantee of future returns. The fund performance changes year after year based on several factors. So, investing solely based on performance will not be an effective strategy.
2. Heavy investments in sectoral and thematic funds
Sectoral and thematic funds choose stocks based on certain themes or belonging to specific sectors. While they may make a fine addition to your portfolio, investing heavily in these funds may not be the best course of action. This is because different sectors and themes may perform differently over the course of your investment tenure. Identifying which sectors or themes may deliver good returns can be challenging at best and impossible at worst.
3. High weightage to mid-cap and small-cap funds
Mid-cap and small-cap funds can be lucrative investments in a bullish market because they tend to have high growth potential. However, on the flip side, they may also react significantly poorly in a bearish market. This increased risk in mid-cap and small-cap funds may not be suitable for all investors. So, if you are not financially or emotionally prepared to endure high levels of risk and volatility, choosing these funds is a mistake you should avoid.
4. Not reviewing your portfolio
Thinking that mutual fund investments do not require constant monitoring is a very common mistake that many investors make. However, as with any market-linked investment option, you must review your mutual fund portfolio periodically. This will help you determine whether it remains aligned with your goals and risk profile or not. If it does not align with them, you can take corrective action and make the necessary adjustments without any unnecessary delays.
5. Not having a financial plan
If you regularly follow market news and analyst opinions, you may find it tempting to invest in mutual funds that make it to the headlines for stellar performance. However, your choice of funds should never be based merely on what’s trending in the market. Instead, what you need is a financial plan that accounts for your short-term, medium-term and long-term goals. You can then choose mutual funds that align with these goals in terms of tenure, risk levels and return potential.
6. Not aligning your investments with your goals
You must always ensure that you invest in a mutual fund that is right for your goals. Investing in a fund that does not match your financial objectives can lead to suboptimal results. For example, if your goal is of a long-term nature such as funding your child’s higher education or marriage, investing in an equity-based mutual fund is the right way to go. This is because equity funds generally tend to do well in the long run compared to debt funds.
7. Ignoring your risk tolerance
Not paying attention to your risk profile is one of the major mistakes to avoid while investing in mutual funds. Many investors do not take the time to assess their risk tolerance before investing. Overlooking this aspect can lead you to invest in a fund that is not suitable for your style of investing. For instance, if you are a conservative investor looking for stable returns and capital preservation, investing in debt funds may be the more ideal choice.
8. Investing short-term money in equity
This is another one of the most common mutual fund investment mistakes that many investors make. Equity funds have historically exhibited better performance in the long run since the impact of market volatility tends to smoothen out as time passes. Therefore, if you have short-term goals to satisfy, it is advisable to avoid investing in equity funds as they are subject to short-term volatility.
9. Trying to time the market
Timing the market involves investing when the markets are low and redeeming when the markets are high. However, getting the timing of your investments right is far more challenging than it may appear due to the unpredictable nature of the financial markets.
As an investor, you would be better off making SIP investment in mutual funds rather than attempting to predict short-term price movements. Systematic Investment Plans (SIPs) involve investing a fixed sum of money in a fund consistently over a long period. This approach negates short-term market volatility and can potentially enhance the returns from your investments.
10. Over-diversifying your mutual fund portfolio
Another very common mutual fund mistake is the over-diversification of mutual fund portfolios. Granted, diversification can help you reduce risk to a certain extent. However, overdoing it could potentially dilute your returns. Fortunately, you can avoid over-diversification by focusing more on the quality of mutual funds rather than the quantity when diversifying your portfolio.
11. Ignoring the fund manager’s track record
The fund manager plays a major role in the performance of a mutual fund. Every action of theirs can impact the fund significantly. Not looking into the fund manager’s track record is one of the few mistakes to avoid while investing in mutual funds. Before you invest in a fund, make sure to thoroughly look into the manager, their track record, expertise and their investment approach. This can give you crucial insights into how the fund is likely to perform in the future.
12. Other mutual fund investment mistakes
In addition to the above-mentioned mistakes that investors commonly make, there are several other lapses of judgement that you need to avoid. Here are some other mistakes to avoid while investing in mutual funds.
- Choosing regular plans
Regular plans are more expensive than direct mutual fund plans. This is because it involves distributor commission, which leads to a higher expense ratio. To optimise your net returns and reduce the cost of investment, it may be a better idea to choose direct plans instead. - Selecting the IDCW option
IDCW or ‘income distribution cum capital withdrawal’ plans may not be as beneficial as they appear to be at first glance. Many investors tend to succumb to the misunderstanding that the IDCW option involves dividend payouts. However, this is only partly true. The income distribution may be in the form of dividends or capital gains from redeeming investments. The latter is not suitable for long-term investors. - Investing in schemes via NFOs
New Fund Offers (NFOs) may seem lucrative because of the low Net Asset Value (NAV) they typically come with. However, low NAVs do not always mean good investment opportunities. Merely reducing the cost of investment is not enough to improve or optimise your returns over the investment tenure. - Investing in equity-oriented with short-term capital
Equity investments are better suited for long-term investment tenures because they help you override the effects of short-term volatility in the market. However, if you use short-term capital to invest in equity mutual funds, you may have to redeem your investments before they have the opportunity to benefit from long-term growth. This can prove to be a costly mistake.
Conclusion
This sums up the common mistakes to avoid while investing in mutual funds. Now that you know what not to do, you can focus more on what you should do to achieve your life goals as planned using mutual funds. The Bajaj Finserv Mutual Funds Platform can be useful to you here. On this platform, you can find over 1,000 mutual fund schemes to choose from. You can compare mutual funds and then shortlist those in which you want to make a lumpsum investment or start a SIP.
