Last Updated on September 12, 2021 at 8:37 am
We list some of the worst mistakes to be avoided while investing in mutual funds. This list is sourced from the questions we have received or encountered at Facebook group Asan Ideas for Wealth over the past 9+ years and is equally applicable to any capital market-related investment product or strategy.
1. I want to invest in this mutual fund (or stock) because its last one year return has been spectacular. This is listed first as I think it is one of the worst investing mistakes. Small cap or mid cap funds and often many thematic or sectoral funds are often chosen this way. Examples are Quant Small Cap Fund, Quant Active Fund, PGIM India Global Equity Opportunities Fund, IT funds etc. (links point to a detailed review of the funds).
Why is this is a mistake? First, we tend to ignore the history of a fund when we do this. Second, we buy assuming such fantastic returns will be reproduced after we start investing. Often the opposite happens because huge returns (or poor returns) in the capital market are typically transient in nature. It is like a surfer on top of a wave, assuming they will never come down. It is also the perfect way to clutter our portfolio with fund after fund.
2. There is a right time to invest: Another worthy inclusion in the worst investment mistakes club. So many investors wait for the markets to correct, to cool down, wasting months and months of precious time that could be spent accumulating mutual fund units (or stocks).
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This is a mistake because the risk never disappears. Waiting results in loss of time, and time is money. Waiting here refers to waiting without any strategy. If you have a strategy (based on, say, PE or moving averages or macro-economic indicators), that is ‘ok’ provided you have the right expectations (see next point).
3 There is a right or best investment strategy or product: If there is one lesson that I have learnt over the last 10+ years, spending countless hours of backtesting investment strategies, it is this: nothing works all the time. Whether buying on dips or buying at low PE and selling at high PE or using DMA or EMAs, nothing will work all the time. What seems like commonsense and intuition is not supported by an open-minded, thorough backtest – at least not all the time.
Every product we choose, every method we choose, be it timing the market or systematic investing, nothing works all the time. To make it clear, this means, sometimes X strategy/product will work and sometimes Y strategy or product. What will work after you start investing is, therefore, completely unknown. So it is plain immature to assume what we have chosen is the best or that we can choose the best strategy or product. So there would soon be a time when Parag Parikh Flexicap Fund would be rated three-stars or maybe even one-star.
So what is the solution? Ask not what is best; instead, ask what is suitable for my need and choose something reasonable. Appreciate that is all that anyone can do.
4 More risk means more return! The financial industry is to blame for this nonsense. Taking a higher risk than investing in, say, an SBI fixed deposit can result in a higher return. This does mean it will result in higher returns. Just because you invest more in mid cap and small cap mutual funds does not mean you will be able to beat a large cap mutual fund portfolio. You may or you may not!
5 Don’t worry about short-term losses; long-term, everything will be okay! I am sorry to say this is just a sales pitch. Reality is considerably different. No matter how long we invest, returns are always uncertain.
6 Information is power: No, it is not! We tend to confuse knowledge with information and follow every reporter, AMC honcho, influence, blog on money for the “latest updates”. The basic principles of money management have not changed for centuries. So once we get a grasp of them, Stay away from all websites (esp mine) and social media related to finance. Give a chance for your money to grow in peace without your interference. I feel the most satisfied when readers email that they “have graduated from freefincal.”
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