Gaurav, who is an engineer by profession, likes to invest in avenues that are risk free. But recently, when he heard about a friend’s investment in mutual funds, generated returns of over 30%, Gaurav decided to take a shot at mutual funds. So he replicated his friend’s portfolio exactly how it was. To his disappointment, he did not earn as much as his friend.
Ms. Sinha, who is a school teacher, has been investing Rs. 10,000 every month in mutual funds through SIPs for a long time. In the recent turn of events due to the COVID crisis, the stock markets crashed, resulting in a tremendous loss in Ms. Sinha’s investment. So, out of panic, to avoid further losses and secure her principal amount, she decided not only to stop her SIP, but to also redeem her entire investment.
Now, even though both these investment stories are entirely different, there’s one common point that ties them together. What do you think that is?
Both Gaurav and Mrs. Sinha made some common investing mistakes that most investors tend to make. It’s good to know about these common mistakes well in advance so that you don’t end up making one.
So, in this blog post, we have decided to list down some of the common investing mistakes that you should avoid making in order to make the most out of your investments in a mutual fund.
#1 Investing Without a Goal & Understanding your Risk Profile
In almost every area of life – whether its fitness, dating, career, or investment – setting goals is extremely important. Once you set a goal, you are determined and focussed to achieve it. We are not saying this. Many recent studies have proven that goal-setting restructures your brain cells in order for you to be more successful in achieving them.
Remember, when you were a kid, your parents promised you a bicycle if you came top 10 in your class. Before this was told to you, you always used to fool around and never take studies so seriously. Now, with the goal of attaining the bicycle in mind, you chucked the casual approach. You became more determined and focussed on studying. All the forces in you started working towards getting that bicycle.
The same goes for investing. Once you have a goal in mind, you get disciplined and focussed. Achieving that goal becomes your first priority. Your brain tries to bring down all possible obstacles that keep you away from achieving these goals. Once you set a goal, like buying a house or going on vacation to your favorite destination, you are less likely to miss your SIPs or tamper with your savings. Because, suddenly, you feel like these goals matter to you the most.
So, you would do anything to make them happen. Think of goals as blinders that are put on horses to not distract them from winning the race.
As important as it is to set a goal, understanding your risk profile is equally important. Different mutual funds have different investment mandates. A large-cap fund must invest 80% of its total assets in the stocks of large-cap companies. Whereas, a conservative hybrid fund, must invest 75% to 90% of their total assets in debt instruments, and the rest 10% to 25% in equity and equity-related instruments. So, the risk associated with every fund category differs because of its portfolio composition. An equity-oriented portfolio will have more risk than a debt-oriented portfolio. So, before investing in mutual funds, you should assess your risk profile. Ask the question – How much risk are you willing to take? Then, choose a scheme that is in line with your risk profile. This way you’ll be relatively safer even if things go south for you.
#2 Selecting a Product Without Proper Due Diligence
Our brain tends to look for shortcuts rather than doing actual hard work. While choosing funds, most of us get smitten by the returns our friend’s portfolio has generated, and want to replicate it to earn similar returns. By doing so, you are taking shortcuts, where you don’t want to take the pain of understanding the product. You forget asking some crucial questions which will be good for your investments – stuff like – where does the fund invest in? What is the risk profile of the fund? Does the fund manager have a good track record? Was the fund able to prevent losses during an economic downturn? Has the fund consistently given good returns?
Although returns are an important parameter to judge a fund’s performance, it is not the only parameter. There are various other factors that are responsible for the fund’s performance. Thus, investors should select a product by properly researching it, and not replicating a friend’s or a celebrity investor’s portfolio. What worked for them, might not work for you. To know what works for you, you’ll have to do some digging into the product.
Look at the objective of the scheme, portfolio construction of the fund (equity or debt oriented), top holdings, risks involved, fund manager details, CAGR/XIRR returns data, and more. An informed investor always has more chances of generating good returns.
#3 Trying to Time the Market
Market timing is a phenomenon that is generally prevalent amongst stock market investors, where they make buying and selling decisions based on their predictions about the future market price movements.
Many mutual fund investors also try to time the market. They try to sell off their investment when they feel the market is going to crash. These predictions might not always be true. Many researchers and experts say it’s impossible to time the market. Moreover, trying to time the market leads to your goals not getting realized. The reason being, by redeeming your investment from time to time, whenever you feel the market is going to crash, you are missing out on opportunities like the benefit of compounding that lets you reach your goal faster.
#4 Reshuffling Your Investment Too Often
Following the herd is something that is very prominent in the investment world. By looking at the returns or a promising headline, makes a lot of investors sway towards doing the same thing. Many investors make the mistake of falling into this trap too often. Based on the predictions based on headlines and by following the herd, they try to reshuffle their investment portfolio too often, attracting exit loads, which eventually eats into your overall returns.
Frequent churning of the portfolio also hampers the growth potential of investments. This is because some funds, like equity funds, perform well only in the long run. Frequent churning would make you lose out on time and bring you back to where you started. So, it will take you more time to realize your goals, and also, you will miss out on various opportunities that happened during the time frame.
#5 Stop Investing When the Markets are Down
When the COVID crisis began, global markets along with Indian markets took a toll. As a result, many investors like Ms. Sinha panicked and stopped their SIPs. That’s a really dangerous practice. What investors forget is that the losses you see as a result of market crash are paper losses and not actual losses. It becomes an actual loss only when you withdraw your investment. You should never do that. Markets are cyclical in nature. It’s not that a bad cycle is going to stay forever. Eventually, markets will correct itself and your investment value will spur, as it happened in the case of COVID pandemic. Market corrections happened and are on an upward trend again.
By stopping your SIPs when the markets are down, you also lose out on the benefit of rupee cost averaging. When you invest in SIPs, you are investing a fixed amount every month at a particular date. The number of units of the scheme you get depends on the day’s NAV. Like we stated earlier, markets are cyclical in nature, they have some good moments along with bad ones. So, when the markets are down, the NAV of the fund you invest in will be low. This means that you’ll get more units of the fund on the day of your SIP installment. Similarly, when the markets are in a good shape, you’ll get more units of the fund due to an increase in NAV. This phenomenon will bring down your average cost of returns thereby shooting up your total returns.
Thus, stopping your SIPs will deprive you of benefiting from this advantage.
#6 Putting All Your Eggs in One Basket
“Putting All Your Eggs in One Basket” is an age-old saying that has been passed from one generation to the other. It simply means – Don’t make everything dependent on one thing. In the investing world, this saying is like one of the Ten Commandments. By putting all your money in a single asset class, you are exposing yourself to great amounts of risk.
For instance, you put all your savings in equities in the pursuit of good returns. But, to your disappointment, the markets crashed, and you ended up getting negative returns. Now, if you would have invested the same amount of money in two different asset classes (equity along with debt), you would not have faced such a huge loss. This process of spreading your investment across different schemes or avenues is called diversification. It brings down the risk in your portfolio.
#7 Not Considering the Impact of Inflation on Returns
One of the common mistakes that most investors tend to make is to ignore the effect of inflation on returns. We all know that the value of the rupee is not the same as what it was 10 years ago. Its worth was way more than what it is today. And after a few years, it will decrease even further. It’s almost inevitable.
In other words, inflation bites into the value of the rupee and decreases its purchasing power. So, while making any investment, your main aim should be to fetch returns that beat inflation.
For instance, let’s say you invest in a Public Provident Fund (PPF), which gives a return of 8% and the rate of inflation is 6%. Here, the real returns that you earn are only 2%, which is very low. Thus, it is very important to understand the impact of inflation and invest in products that can shield yourself from rising inflation. Mutual funds are one such product that can help you beat inflation and generate good returns for you. Always remember, it’s always the inflation-adjusted returns that count. Returns after accounting for inflation are the real returns earned by you.
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