7 Mutual Funds Do's and Don'ts

Life (including investments) is not about not making mistakes, but to learn from them. A wise person quickly learns from his mistakes - and those of the others too. Given below are 7 do’s and don’ts which we can follow to avoid mistakes commonly made by investors in MFs.

Rule 1 :  Don’t look at NAV
I would be repeating this maybe a 100th time – Rs 10 NAV does NOT mean that the fund is cheaper than an existing fund with say Rs 200 NAV. Therefore, never look at NAV when you are making an investment decision.

Rule 2 :  Do systematic investment
The market valuations today, despite the recent correction, are still not cheap. Also, there is risk of a possible slowdown in the economy. Therefore, averaging one’s investment by doing SIP is a safer route to investing in equity markets.

Lump-sum investment is advisable only at very low market PE levels, when the risk of markets going down further is low and the probability of appreciation high.

Of course, this does not apply so much to debt funds, where the returns are relatively much more stable.

Rule 3 :  Don’t go for Dividend option
If the investment horizon is more than 1 year (which should ideally be the case when one invests in equity funds), Growth option is generally preferable both from the point of view of wealth creation and tax efficiency. For investment period less than 1 year for the short-term needs – and usually invested in debt funds – dividend option would generally be better.  

Rule 4 :  Don’t have too many or too few funds
Don’t invest in too many or too few funds. While, there is no specific number of funds which you may own, a portfolio of 12-18 funds should in most cases be OK.

Too large a portfolio will mean many similar funds, which could dilute your overall returns. Too small a portfolio will mean that you are not covering the entire breadth of the market, besides exposing yourself to high risk of a concentrated portfolio.

Further, your corpus should be appropriately spread across large-cap/diversified funds, mid-cap funds and sector funds from different fund houses. Large-cap/diversified funds are relatively less risky, mid-cap funds are riskier and sector funds carry highest risk. Therefore, to have a balanced and stable portfolio, maximum money should go to large-cap/diversified funds, some amount to mid-caps and only a small portion should be invested in sector funds.

I have seen many portfolios which are stacked with infrastructure funds (the latest market fancy). Such concentrated portfolios carry very high risk.

Rule 5 :  Don’t invest in New Fund Offers
Do not invest in NFOs; unless they have something very different to offer, which the existing funds don’t.

Since there is no portfolio or performance to look it, it is difficult to assess whether the fund would add value to our portfolio or not. Besides, most of the NFOs launched today are the risky sector funds.

Rule 6 :  Do your own study before investing
Ads are meant to lure people. Therefore, it will not be prudent to invest just because some advertisements say so.

Further, it would also not be prudent to blindly trust your distributor (especially those who are not professional advisors too). One, they may not be fully equipped to understand your needs and advise accordingly. Two, they may not be selling all the products you may need. Three, they may be guided more by their commissions than your interest.

Hence, always cross-check the advice you receive with multiple sources, before you commit your money.

Rule 7 :  Don’t invest too much in global funds
Be very careful when investing in global funds. Global funds would probably be the riskiest amongst the equity funds. Like any equity funds, they face the equity-risk.

Besides this they are also open to currency risk. If the rupee appreciates, you will get less rupees/dollar. Therefore, it is possible that whatever returns you make in dollar terms, may get fully eroded if in the meantime the dollar has depreciated. Given the strength of the Indian economy vis-à-vis the US/Europe etc., the chances of rupee appreciation are high. In fact, had RBI not intervened, dollar might have already depreciated to Rs 35-38.

Therefore, invest only a small percentage of your corpus in good diversified global funds; that too primarily for diversification purposes.

These rules will guide an uninformed investor to invest his money wisely and profit from the potential that the Indian economy offers today.

- Sanjay Matai

The author is an investment advisor and promoter of wealtharchitects.in. He can be reached at sanjay.matai@moneycontrol.com.

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