Posted On Wednesday, Jun 10, 2015
It’s said choosing a mutual fund is like choosing a spouse. Investors need to know everything about the fund before taking the leap. However there are many times when investors take the wrong route for investments and eventually face its consequences. Let me share some very common mistakes investors do and must avoid.
1. Ignoring the Expense Ratio
While investing in a mutual fund is definitely not a humongous task, it is important to take note of small things like the expense ratio before investors choose to park their hard earned money with fund houses. Since expense ratio is a charge deducted from assets, it is implied that higher the expense ratio, higher the charge on their investments. Also longer their investment period, higher is the impact of expense ratio on their returns.
This fact is demonstrated in the illustration below.
|Value of Rs 1 lac on 12% MF annual returns and various expense ratios|
|Expense Ratio (%)||5 yrs (in Rs)||10 yrs (in Rs)||15 yrs (in Rs)||20 yrs (in Rs)|
|Difference in highest & lowest||10,212||32,758||78,835||1,68,701|
Table used above is for illustrative purpose only.
In the above example, the difference between the expense ratios of the three funds is probably because of the higher commissions, management fees, marketing budget etc paid by the Fund B and Fund C. It is like losing Rs 1.68 lakhs over 20 years, i.e. about Rs 8,000 annually.
Expense ratio of direct plan funds are lower compared to regular plans since the former is bought directly from the AMC.
Difference in return gets magnified with a higher investment period so it would be prudent to pay attention to what their fund’s expense ratio is, especially as a long term investor. It is unwise to ignore the Expense ratio before investing in mutual funds as it would certainly be useful in choosing between funds of the same category when the performance of both funds is on par.
2. Lack of investment discipline
Markets reach all-time highs and investors start to receive calls to either invest or even worse exit their investments and ‘cash in’. In an effort to make the most of the market rally, the mistake they generally make is to exit from their investments - investments which could have the potential to give them much more than they might have got - the investment that had still not reached its target ie their financial goal. When investing, investors need to understand, that it is very important to continue being disciplined and that investments should always be linked to their financial goals. This stands true, especially in the case of Equities.
Equities are more of a long term investment option, since equities as an asset class have the potential to give good returns over a long period of time (with higher risk). Therefore, it is advised that investors hold on to their investments even if the markets are not moving in a favorable direction.
Moreover there is one way investors can negate the effects of market cycles and also brings financial discipline in their investments – SIPs. Systematic Investment Plans or SIPs are said to be an ideal way for investors to create wealth in the long term.
Below is an illustrative example that shows how it helps to be a discipline investor from an early age and invest with SIPs.
|Amount of SIP (Rs.)||Frequency||Total No. of Years of Investment/ Age of Investing||Rate of Return||Total Amount Invested (In lakhs)||Corpus Build (In lakhs)|
*Table is for illustrative purpose
Person A builds a corpus of Rs 35.30 lakhs while person B`s corpus is only Rs 18.98 lakhs. So the difference of Rs 60,000 in amount invested made a difference of approx. Rs 16 lakhs to their end-corpus. That difference is due to the power of compounding. Hence, with disciplined approach and longer compounding period, investors can enjoy potential higher returns.
3. Not doing adequate research before investing
Finance is an alien language for many investors. When it comes to investing they generally rely on their financial advisor or distributor. Following the advice given to them by their advisor or distributor might be their only resort but in my view they should surely do some research on their own. With the advent of the internet it has become a lot easier to simply key in the name of the fund, check the performance etc before investing. Investors need to understand, that investing, especially in equitys comes with associated risk. Therefore basic research on which kind of asset class should they park their money in, whether the fund they are looking for has a good track record in the past, etc will help them be that much more confident while making the investment.
4. Compromising financial goals for some quick gains
The tenure of investor’s goal will determine which asset class investors should invest their hard earned money. May it be further studies they wish to pursue abroad or their own marriage or retirement. It is very important for an investor to decide the goal for which he/she is investing and stick with the investment for the tenure of that goal. Investments made for retirement should not be cashed in only because the markets are on a high. Our advice to investors has been to withdraw their investments based on need and not on greed. Greed is good only in the movies, not in reality!
Thus if an investor’s financial goal is short term than he/she might have to invest in debt schemes which tend to have considerably low risk. However if the financial goal is for the long term investors should ideally invest in equity provided they have a high risk appetite, as equities tend to give higher returns with higher risk over a long term period. Investments should not be subject to any market up-swing or external influence.
5. Investment decision based only on returns and not the risks associated
Surprisingly, most people start investing without any real strategy. They park their hard earned money across asset classes without as much as a second glance at their personal risk taking capacity. And that’s pretty tragic considering that their risk profile would be starkly different from that of their next door neighbor, on whose recommendation investors tend to buy stocks, when we hear that he has made gains of x%!
Always consider the risk involved while investing be it in a mutual fund, insurance etc. Investors should ideally look for sensible, risk-adjusted returns over the long term through a fund house that follows a disciplined research and investment process. Look at the track record of the fund house, and the process they have in place to ascertain the risk investors are taking, not how big the fund house is. Remember, the returns that a mutual fund could make, is not a function of size. The Risk-Return analysis is yet an important aspect of mutual fund investing.
6. Last minute tax saving
Come the month of January, February and March and employees look for ways to save tax. In my view tax investments in mutual funds through ELSS have dual benefits. First and the obvious being it helps investors get tax exemption and second is it helps them create wealth. However many investors miss this opportunity.
There are several advantages of starting early, say in May iteself rather than in February:-
• Investors could save tax more efficiently and capitalize on investment returns.
• They can avoid the last minute paper work and mistakes.
• Investors can save small amounts regularly through SIPs and avoid the circumstance where they end up not having enough money to spare for a lump sum investment at one go.
7. Considering funds with higher NAV perform better than those with lower NAV
Sometimes investors tend to link NAV to absolute returns of a fund. Therefore higher NAV is taken to be synonymous with higher return. This is not necessarily true. NAV sure is a tool to measure performance but NAV is not a performance indicator in itself. It is change in NAV of two dates that reflects performance of the fund in the period between those dates. However it is true that with age the NAV of a fund increases; that’s why older funds tend to have higher NAVs.
For instance suppose an investor invests in a fund with NAV 10 which grows to 60 in 10 years. At the same time his neighbor invests in another fund with NAV 150 which grows to 250 in the same period. Although NAV of the latter was much higher its annual return is only 5% compared to 20% of his fund.
|NAV at start||NAV after 10 years||Annual return (CAGR)|
Disclaimer: Table above is for illustrative purpose only. NAVs used are fictitious...
There are true examples of funds today which have the highest NAVs among their peer category of funds but whose performance is dismal. What is important is that investors select a good fund (as known from its past performance over various market cycles), backed by strong fundamentals, irrespective of whether its current NAV is in double digits or triple digits.
Therefore in my view investors should always avoid these 7 habits when investing only then can they experience the true potential of mutual funds. Investors should consult with a financial advisor while making investment decisions.
Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.
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