In the constantly evolving world of financial investments, mutual funds are a go-to investment option for many investors. The reason is that there is a wide range of mutual funds available to investors, catering to their different investment preferences and risk tolerance levels. As a result, investors have the opportunity to invest in mutual funds that align with their unique investment goals and risk appetite.
However, novice investors who are interested in mutual funds may misinterpret some aspects and make mistakes that other inexperienced investors make. To help investors avoid common mistakes while investing in mutual funds, this blog outlines seven errors to look out for.
Table of Contents
Mutual Funds: Introduction
- Mutual funds are a basket of investments in which investors collect their money and invest in different classes of assets, securities, markets, and sectors.
- Professional fund managers are responsible for using their expertise to invest and manage these investments based on the fund’s pre-determined objective.
- Mutual fund schemes are offered by Asset Management Companies (AMCs) that take responsibility for collecting investors’ funds and reinvesting them.
- Mutual fund distributors are the agents who aid investors in buying and selling mutual funds.
- All these intermediaries and experts work under the guidelines provided by the Securities and Exchange Board of India (SEBI) to promote transparency and fair market practices.
Mutual Funds: Benefits
Mutual funds are a favoured investment choice because they offer a plethora of advantages, which include:
Secure Investment Option
SEBI and the Association of Mutual Funds in India (AMFI) are the two statutory bodies that regulate the mutual fund industry in India and set regulations for intermediaries and companies to maintain ethical business practices. These bodies promote investors’ interests and keep them informed about the mutual fund industry, making mutual funds a relatively secure and safe investment option.
Diversification
There are several ways to diversify one’s portfolio while investing. Investors might not know the best way to diversify their portfolios and may end up suffering losses. Professional fund managers who manage mutual funds assist investors in investing in different asset classes and sectors that align with their risk tolerance and funds’ stated objectives.
Suitable for Young Investors
Young investors are flexible and usually tolerate risk better than their older counterparts. Additionally, they have ample time to benefit from compounding. Therefore, mutual funds are suitable investment choices for young investors. Young investors can always start small and reap big as they age if they stay invested for long.
Professional Management
Investing money can be challenging, especially if you are not familiar with the financial markets. Mutual funds, unlike other types of investments, have an edge due to the expertise of their fund managers. These professionals possess significant knowledge and experience in managing assets and navigating the markets, making mutual funds a more secure and reliable investment option.
7 Common Mistakes to Avoid When Investing in Mutual Funds
Sole Reliance on Historical Performance
Historical information does not always guarantee success in mutual fund investments. Selecting funds solely based on past performance can be detrimental to investors as factors like market conditions, interest rates, and fund strategies change over time. Therefore, investors must select funds based on their investment objectives and risk exposure.
Starting Without a Financial Plan
A wise man once said, ‘By failing to prepare, you are preparing to fail.’ Every investor must have a solid financial plan after considering the pros and cons of each kind of mutual fund scheme. Traders should assess their risk appetite and investment goals and select funds that align with those requirements.
Having Unrealistic Expectations
It is tempting to have high expectations after hearing the success stories of fellow experienced investors. There might be a chance that the investors will achieve success. However, these funds are subject to market risk, which is uncontrollable at times. Hence, expecting guaranteed success is just delusional thinking.
Imitating Other Investors and Their Strategies
Many investors share their success stories and provide strategies to follow for achieving success. These strategies can appear to be a guaranteed path to success for inexperienced investors. While there is nothing wrong with imitating other investors and their strategies, traders must have sufficient knowledge to understand why those fund analysing strategies work and decide for themselves whether or not to use them according to their risk tolerance and investment style.
Treating Mutual Funds like Equity
Investors often make the mistake of having unrealistic expectations when it comes to investing in mutual fund schemes. They expect high returns in a short period of time. However, while some mutual fund schemes are suitable for short-term returns, they still require patience from investors and periodic monitoring. Fund managers also need time to conduct rigorous research and select stocks as per the fund’s objectives. Investors must avoid buying and selling mutual funds like equity funds, as it can lead to poor returns and losses.
Neglecting the Need for Portfolio Rebalancing
Portfolio rebalancing is a pivotal part of investment management. Some funds perform exceptionally well for a few years, and investors keep those investments for years based on their initial performance. However, these investments may decline in performance over time. Investors need to periodically review their portfolios, get rid of underperforming investments, and look for new funds to invest in. This act rebalances the portfolio and creates an optimised portfolio.
Investing Heavily in Small-Cap Funds
Small-cap funds invest in small-cap companies with a market capitalisation of less than ₹5000 crores. These funds attract retail investors due to their growth potential. However, they tend to be highly volatile investments and require investment expertise. Heavy investment in small-cap investments is a risky venture, even for experienced investors. Therefore, it is advisable to use them as a tool for diversification.
Conclusion
More is always better in the case of research and knowledge in the field of mutual funds. Investors must do their part of the research before investing in mutual funds and periodically check on their portfolio performance. Investors must keep in mind that they should refrain from following mutual fund schemes mindlessly and optimise their portfolios based on their risk appetite and investment style.
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