Avoid these pitfalls while investing in mutual funds

Research about investor behavior and analysis show that the average investor earned below-average returns across various periods of time. This is especially true with retail mutual fund (MF) investors where they tend to under-earn than the benchmarks or broader market indices.

In many cases, they earn returns lesser than the fund has generated. This is more to do with the investor and their behavior than the fund performance.

One of the main reasons is the investors’ futile exercise to time the market. One can’t be always be lucky to end up entering at the bottom or near-bottom and exiting at high or near-highs.

This again could be countered by profit booking after a particular amount of pre-defined returns or targeted returns. The other way is to ensure phased exits from the investment as the goal timelines near. This way the accrued returns achieve the goals while protecting the gains.

When investors flock to take advantage checking the past performance as a parameter, the experience could be divergent from their expectations. This is because they end up contributing at a higher level and also at times most of their investible surplus as one-time investment leading to wrong entries.

And in the ensuing panic, the investors were to redeem and back out of the investment, the notional losses turn real. This is the other reason why one has to disperse the surplus and chose either of systematic investment or systematic transfer plans (STP).

While Systematic Investment Plans (SIP) book has been swelling and reached record highs which add about Rs 8,000 crore month-on-month by over 2.5 crore accounts at an average SIP investor amount of little over Rs 3,000 per month.

The one year returns on most of the MF have been in negative excepting for a bunch of large-cap oriented MF and a sectorial funds of Information Technology. This drives pangs for many investors as the returns have been dismal while this was preceded by an astounding year of higher returns on many equity MFs.

Even for investors of SIP over a three year may find their current returns are in single digits. So, one should understand that SIP doesn’t completely offer shield against the vagaries of the stock market volatility but certainly mitigate part of the risk. Moreover, it also solves a part of the ‘timing’ the market concept as the systematic investments expose the corpus at various levels of the equity markets.

Quoting economist, Gene Fama Jr, “your money is like a bar of soap. The more you handle it, the less you’ll have.” This is apt for those investors who constantly look at their investment portfolios and try to navigate the markets.

Investors would end up better by sticking to the basics of risk appetite, timelines and goals than responding to the macro economic factors, geo-political changes and other exogenous factors where they’ve no control at all.

Of course, it’s human nature to act or be in action mode most of the time. This leads us to react to every situation and/or expect our advisor to respond to all the evolving changes in the market place.

This is one important aspect that needs to be discarded by the investor if they were to make more money. Most times, it’s better to not react than to react. Doing nothing is hence is doing everything in these cases. Exercising patience is primal instinct of great investors.

Diversification is essential but over-diversification just does more harm than good. Chasing returns is another reason for over-diversification. Investors trying to ride on many ideas explore too many options and hence dilute the whole idea, thus losing out across.

Another offshoot of diversification is the asset allocation where many investors ignore when the going is good. When equities are having a ball, many investors overweight their portfolios with the same asset class and ignore their asset allocation. The asset allocation should be reflective of their risk appetite and goals and hence couldn’t be ignored.

Therefore, a MF portfolio should be created which is non-correlated or less correlated within the asset class which represents the investor’s risk profile and tolerance with a review mechanism to chase the timelines defined by their goals. (The author is a co-founder of “Wealocity”, a wealth management firm, and could be reached at [email protected])