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Top 4 Mutual Fund Errors to Avoid

Submitted by admin on November 18th, 2024

Investing in mutual funds has emerged as one of the most popular investment avenues for Indians. With the potential for good returns and the convenience they offer, it’s no wonder that investors are increasingly turning towards mutual funds. However, just like any other investment, mutual funds come with their own set of challenges, and uninformed decisions can lead to total losses. Therefore, common mutual fund mistakes are something that an investor should be aware of. Let’s dive deep into exploring those top mutual fund mistakes you should avoid.

1. Overlooking Holistic Financial Planning

Error: Most people rush into the investment in mutual funds without setting proper risk appetite, knowing about the overall financial situation, adequate stash of funds for emergencies, etc. They begin investing in random funds without even knowing whether that fund will suit them. According to the SEBI report, 90% of investors withdraw their mutual fund investments within 3 years of investment. Investors can’t stick to their plans because their portfolios aren’t aligned with their psychological needs. People tend to withdraw their investments when there is turmoil in the market.

Solution: A holistic financial understanding is quite crucial. Knowing the assets, liabilities, short-term and long-term needs, retirement planning, etc., helps you make the correct choices. One should prefer taking qualified advice to align your overall finances.

2. Investing based on past performance

Error: The investors get carried away by numerical data and make decisions purely based on it. A typical error they make is that of making investments solely by funds on the basis of their past historical performances. Some investors assume the past performance period coincides with the actual investment horizon of that fund. For example, if a fund has performed well during the last three years, it is assumed that it is a good choice for investment for a three-year period. A fund’s past performance cannot be used to predict future returns.

Solution: Instead of emphasizing just the historical returns, it is important to look into the basic ratios of the fund. Analyze the risk profile of the fund, its resistance to loss in a falling market and uniform performance during fluctuations, experience of the fund manager etc.

3. Overdiversifying Your Portfolio

Error: Though diversification helps to reduce the risk, over-diversification can lead to duplicated portfolios holding the same holdings in different schemes. 60% of the Indian industry’s AUM in equity MFs is invested in Nifty 50 stocks, so you may come across the same set of stocks in many funds, say for instance large-cap category- majority of your fund’s portfolio look similar. Over-diversification is not only expensive but also tough to track too many schemes.

Solution: Portfolio efficiency. Rather than spreading investments in too many funds, use few efficient funds and let them actually align with your financial goals.

4. Ignoring Expense Ratios: An Expensive Mistake

Error: The expense ratio is the percentage of fund assets spent on administrative and operational costs. A high expense ratio digs into the returns on your investment. In mutual funds, under every scheme category, there are two options available. Direct & Regular- The regular investment option tends to have a higher expense ratio due to commissions to agents. On the contrary, direct options have lower expense ratios with no distribution cost.

Solution: Compare and contrast expense ratios between similar types of funds. Use a direct option to avoid the large distributor commission. Index funds are also far cheaper than their active type counterparts.