As investors adopt a long-term perspective and recognise that short-term market fluctuations are part of wealth creation, MFs have become the go-to asset class for a large number of investors. Right branding, simplified KYC and digital onboarding are cited among the most prominent reasons behind this shift. However, novice investors are prone to making mistakes that could cost them a great deal. This guide lists mistakes most rookie mutual fund investors are prone to making.
Starting without no plan
Irrespective of the asset class, the investor must have a plan in place before they start investing in order to meet specific goals. Those who enter the areas without any planning, tend to make two completely different kinds of mistakes. Some beginners, in their enthusiasm to build wealth quickly, overlook their risk tolerance, often investing in too risky funds. The second type sticks with only conservative funds, often wasting a wealth-building opportunity mutual funds present. In both cases, it becomes a loss-making pursuit.
Getting in for quick gains
Rushing means not applying due diligence. Considering MF investing has its own nuances, being in a hurry could be detrimental to the end goal.
Judging funds by performance
For someone who has just started investing, referring to the past performance of funds is only natural. However, the mistake here is that top performers change every year and only because a fund had double-digit growth in the past three years, does not mean its winning streak is going to continue. While factoring in past performance is a good basis to build on, one must factor in other factors such as sectoral performance, economic progress and geopolitical situation.
Not paying attention to expense ratio
MFs charge an annual fee named expense ratio of 0.2 per cent to 2 per cent. This is one detail that most rookie investors don’t pay much attention to at the time of investing, ultimately affecting their long-term returns. The loss becomes quite prominent when compounded over decades. For example, if a fund earns 10 per cent returns before costs but charges a 2 per cent expense ratio, the net return falls to 8 per cent. Over 20 years, an investment of Rs 10 lakh could end up with around Rs 2.67 lakh less, translating to nearly a 43.6 per cent lower final corpus due to seemingly small annual costs.
Following gut feeling on sectoral and thematic MFs
Sectoral and thematic MFs have a high-risk, high-reward character. Because of its second characteristic, it has become the largest category in the equity MF space. While someone with a deep understanding of a sector due to long-term exposure, predicting outcomes might be possible. But for a rookie investor, making such predictions could be “guess work” or “gut-feeling”. Not paying attention to where these funds fit within your portfolios could be highly detrimental to wealth generation.
Not factoring in taxes
In order to correctly assess the gains you are able to make through MF investing, understanding tax implications on profits is extremely important. MF returns in India are taxed either as capital gains. Capital gains tax applies when units are sold, and depends on fund type and holding period. Equity funds are taxed at 20 per cent for short-term and 12.5 per cent on long-term gains above Rs 1.25 lakh. Debt funds are mostly taxed as per income slab rates, with limited long-term benefits. Hybrid funds follow either equity or debt rules. Dividends are taxed as income at slab rates, with 10 per cent TDS above Rs 5,000. Overall, taxes can significantly reduce actual returns, making tax planning essential for investors.
No timely portfolio review
Just like everything else, your portfolio requires constant monitoring and regular reviews. That way, one can gauge future outcomes and plan a strategy. Not doing so is one sure-shot way to allow under-performance go undetected, make over-payments, lose out compounding and be ill prepared for changing market conditions. All in all, failure to monitor and review could result in your investments deviating from what you intend to do with them.
FAQs
How do emotions shape mutual fund investment performance?
Reacting to market volatility, meaning buying in bull phases and exiting during downturns, leads to poor timing. This behaviour often results in lower returns than the fund’s actual long-term performance.
How does ignoring asset allocation impact long-term returns?
Without proper allocation across equity, debt and other assets, portfolios become unbalanced. This increases risk during market downturns and reduces the ability to generate stable, long-term returns.
How can beginners avoid mutual fund investing mistakes?
They should set clear goals, diversify investments, stay invested for the long term, review portfolios regularly and understand costs and risks before investing.