Kolkata, January 15: It falls under the knowledge of common minds that investing in equities is vital if one wants to generate returns that beat inflation. And mutual funds are the most preferred way for retail investors to get exposure to equity. However, mutual fund investors are liable to make some common mistakes that defeat the purpose of mutual fund investments. We take a look at some of them and the precautions you must take to avoid being the victim of such mistakes.
Misunderstanding the concept of past returns and future returns: If you hear the mutual fund investment disclaimer carefully, it states that mutual funds are subject to market risks. Mutual funds are market-linked products and can give zero or even negative returns. It is a common practice to look at past returns of a mutual fund over a year, three years and five years period, but past returns do not guarantee future performance in any way. It does give an indication of how the fund has performed in the past and it can be studied to see how the fund has performed in various market cycles, however, future returns may be totally different. So even a five-star rated fund may not give you great returns in the future.
Not understanding the type of funds: Mutual funds are of different types. There are equity funds and debt funds and there are further types of each fund. The type of fund you are choosing has to be in line with your risk appetite and investment goal. For example, if you are looking for stable but moderate returns you should invest in large-cap funds. If you are looking for a fund that is investing across several market caps, you should go for a multi-cap fund. If you are looking for a mutual fund that is investing in a certain sector, you should go for sectoral funds. Sebi has categorised mutual fund types based on their investment mandate. It is predominant to understand the fund type and align it with your investment goals.
Stopping SIPs when the markets are down: When the markets are correcting, mutual fund SIPs can give low or even negative returns. Many investors tend to pull out of SIPs in such a scenario. That is not a wise thing to do as SIPs work on the concept of rupee cost averaging. When the NAV of a mutual fund is down you buy more units and when the prices go up, you buy fewer units. Even during the phase of poor performance in the market, you need to continue with your SIPs. There can be situations where you need to remove or replace a weakly performing mutual funds from your fund portfolio, however, that falls entirely a different dimension.
Not investing in the long term: Equities are good investments but only when done properly. If you are investing in a time frame of two or three years in mutual funds, that may not be a good idea. Over a short period, mutual fund returns may be low due to market volatility. It is advisable to invest in mutual funds only if you have a time horizon of five years.
Overexposure to mid and small-cap funds: Mid-cap funds and small-cap funds have the potential to generate exponential returns but they may also perform very badly when the markets are falling and maybe giving double-digit negative returns over a period of time. Your exposure to small-cap and mid-cap funds should be based on your risk appetite. Even then, you should only have a small portion of your portfolio in such funds. There are times when mid-cap and small-cap funds will be generating huge returns and one might be tempted to put all of one’s money in them. But that activity must be avoided.