Picture this: Mr. Rajat, a data analyst, decided to invest Rs. 1,00,000 in mutual funds. He carefully studied the market and bought the most promising stocks. He saw profits rolling in for the first month and felt extremely excited. However, in the second month, Mr. Rajat noticed his portfolio dropped in value unexpectedly, and without much thought, he liquidated all his investments quickly to purchase new funds. After only 20 days, the shares Mr. Rajat had impulsively sold significantly increased in value, leaving him with nothing but regret.
Mr. Rajat’s lack of patience is one of the common mistakes investors make when buying mutual funds. There are many more pitfalls that even experienced investors can fall into, such as over-diversifying with one fund, choosing funds with high expense ratios, or chasing past performance only.
These basic yet costly errors can make your investments ineffective or even unprofitable over time. Let’s go through such mistakes in detail, along with strategies to avoid them.
- Inadequate research and focusing solely on past performance
A mutual fund scheme with a good track record doesn’t mean it will continue to perform the same. Track records provide useful information but they don’t always predict future performance. So it’s important to look beyond past performance and consider more aspects. Scheme-related documents can be used to understand the scheme’s suitability, investment objective, asset allocation pattern, fund manager, investment strategy, risk factors, and mitigation factors.
- Over diversification
Diversifying your investment portfolio is essential, but some investors focus on too much diversification.
Over-diversification is when an investor invests in many mutual funds, hoping to cover every asset class possible. This approach, however, often leads to poor portfolio performance because every mutual fund has a specific objective, feature, risk, and return profile, and investing in too many funds might blur the overall objective.
Try to invest in a few high-performing and best mutual funds rather than investing in too many with low returns. Such strategies are useful to maximise returns and help investors avoid investing across multiple underperforming funds.
- Timing the market
Investors frequently attempt to predict market trends and make investment decisions based on their market growth or decline predictions. This strategy is difficult and also risky because even experienced investors need help to predict market changes accurately.
When investors attempt to time the market, they can lose opportunities or even incur losses as the costs of frequent transactions can add up with time. Thus, it is advisable to prioritise long-term strategy, and a better approach is to invest via Systematic Investment Plans (SIPs). With regular investments at fixed intervals, SIP eliminates the need for market timing and brings discipline to long-term investing.
- Lack of patience and emotion-based decisions
Many investors make the mistake of being impatient, and they expect quick returns from their mutual fund investments. This impulsive behaviour can lead to short-term losses and missed long-term gains.
For example, some investors may buy overvalued shares just because their friends or colleagues are buying them and face losses in the future. Thus, have realistic expectations and make rational decisions based on a well-thought-out investment plan.
- Not rebalancing the existing portfolio before buying new funds
Not rebalancing the portfolio periodically can result in a misaligned diversified investment strategy and more risk exposure.
For example, an investor’s portfolio might have consisted of 60% stock and 40% bonds initially. But the equity market performs better, and now stocks form 80% of the portfolio while bonds only cover 20%. If the investor doesn’t adjust the portfolio or makes additional stock purchases, the portfolio will become overexposed to market volatility. Thus, it is crucial to monitor and rebalance portfolios regularly to avoid over concentration in a single sector, company, or asset class and minimise potential losses.
Don’t go wrong with your investments and avoid costly mutual fund mistakes
Investments in mutual funds can be a great way to build wealth, but investors must be aware of the potential pitfalls. Avoid following the herd mentality and buying every popular fund. Instead, research and analyse the fund’s past performance, fees, and expenses.
Remember, patience and a long-term perspective are important to reap the benefits of mutual funds. Most importantly, seek professional advice to gain valuable insights and a personalised approach to take advantage of opportunities in volatile markets and avoid unnecessary mistakes.