Mutual funds have become one of the most popular investment options for millions of Indian investors looking to grow their wealth over the long run. However, with thousands of mutual fund schemes available across different categories like equity, debt, along with hybrid as well as more, choosing the right mutual funds can be an overwhelming task if not done carefully. Many investors often end up making mistakes that negatively impact their investment returns. In this article, we will discuss 5 common mistakes that investors should avoid when selecting mutual funds.
- Not having clear investment goals and time horizon
One of the biggest mistakes investors make is investing in mutual funds without properly defining their financial goals as well as the time period for which they want to invest. Different mutual fund categories cater to different goals along with time horizons. For example, equity funds are best suited for goals 5 years or more away due to market volatility in the short run, while debt funds are better for goals within 3 years. Taking hasty investment decisions without clarity on goals as well as timelines often leads to poor performance. Investors must first identify their goals like child’s education, retirement, buying a house etc as well as the required time period before choosing suitable mutual funds.
- Focusing only on past returns
Many investors fall into the trap of choosing funds solely based on their impressive returns over the last 1 or 3 years, without considering other important factors. While past performance is one metric to evaluate a fund, it is not always indicative of future returns. Market conditions keep changing as well as a fund that delivered high returns in a bull market may underperform in a bear phase. Investors must look at other critical parameters like the fund manager’s experience along with track record, investment style as well as process, portfolio diversification, along with risk adjusted returns as well as expense ratios to make an informed choice.
- Herd mentality and choosing flavour of the season funds
When a particular sector, style or category of funds start delivering higher returns than others, many investors tend to pile into those ‘flavour of the season’ funds without independent research. This herd mentality often leads them to buy high as well as sell low. While it is good to consider top performing funds, one must do their own due diligence to understand if the factors contributing to past outperformance are sustainable. Diversification across sectors, along with styles as well as fund houses is prudent rather than narrow focus.
- Not reviewing funds periodically
Many investors make the mistake of choosing mutual funds as well as then ignoring them completely without periodic reviews. Market along with economic conditions keep evolving constantly. A fund that was well suited 5 years back may no longer meet the changed goals, timelines or risk profile of the investor. Fund managers as well as research teams in fund houses also change from time to time. Regular reviews help identify funds that have consistently underperformed peers or deviated significantly from stated objectives requiring an exit. Rebalancing as well as realigning the portfolio to the investor’s evolving needs is important for optimal returns.
- Chasing short term performance and frequent churning
Some investors tend to frequently switch in as well as out of funds chasing short term performance fluctuations in the market. This ‘churning’ of funds leads to additional expense burden through exit loads as well as capital gains tax. It also does not allow sufficient time for the power of compounding to generate higher long-term returns. Mutual funds are meant for investments of 3-5 years or more to generate wealth over the long run. Unless there is a major change in fund management or objectives, investors must stay patient as well as invested for the recommended time horizon rather than chasing temporary market movements.
Understanding the types of mutual funds and choosing the right ones require diligent research, discipline as well as patience on the part of investors. By avoiding the common mistakes discussed above like lack of goals, herd mentality, chasing returns along with frequent churning, investors can select optimal funds that meet their needs as well as help achieve life’s financial milestones. Proper planning as well as periodic reviews also ensure funds continue to remain well aligned to the evolving requirements.