10 secrets of Mutual Fund investing
What do you think – is investment a problem or solution? Who does your investment make rich –you or the middleman i.e. the mutual fund, broker, distributor, rating agency, company promoter etc? How do you select a MF scheme – on your knowledge, experience or judgment or based on some recommendation or tip by a so called fund expert or market guru? Have you ever lost money in absolute terms i.e. entire or a part of your capital? Have you ever lost money in relative terms i.e. your investments earning positive returns but much less than the other alternative investments? Have you been able to differentiate between good and bad mutual fund schemes? Do you know the true clandestine of long term wealth creation? If not, then read on to unlock the true secrets of mutual fund investing.
1. Avoid the herd mentality
The typical mutual fund investors buy decision is usually heavily influenced by the actions of his acquaintances, neighbors or relatives. Thus, if everybody around is investing in a particular fund, the tendency for potential investors is to do the same. But this strategy is bound to backfire in the long term. No need to say that you should always avoid having the herd mentality if you don't want to lose your hard-earned money in the markets. And this rule applies to a mutual fund investor as well as a fund manager. The world's greatest investor Warren Buffett was surely not wrong when he said, "Be fearful when others are greedy, and be greedy when others are fearful!"
2. Take informed decision
Proper research should always be undertaken before investing in funds. But that is rarely done. If you don't have time or temperament for studying the markets, you may even take the help of a financial advisor.
3. Invest in business you understand
Never invest in a fund which you don’t understand. Never buy a fund which has a low NAV but always invest in a fund which has a good underlying portfolio of stocks, bonds or whatever the case which may be. And invest in the fund which you understand – equity, fixed income, money market, commodity, hybrid etc. Don’t invest in fancy fund names, sector or thematic funds – remember they are just fads by mutual fund managers and their distributors to loot the gullible investor of his hard earned money. Understand, for instance, what your fund buys and sells, and how they make money. Thus, the more you understand the business of the company, the better you will be able to monitor your mutual fund investment.
4. Don't try to time the Fund
One thing that even Warren Buffett doesn't do is to try to time the stock market, although he does have a very strong view on the price levels appropriate to individual shares. A majority of investors, however, do just the opposite, something that financial planners have always been warning them to avoid, and thus lose their hard-earned money in the process. So, you should never try to time the market. In fact, nobody has ever done this successfully and consistently over multiple business or market cycles. Catching the tops and bottoms is a myth. It is so till today and will remain so in the future. In fact, in doing so, more people have lost far more money than people who have made money. And if you can’t time the market than it is a sine qua non that you would not be able to and never try to time your mutual fund investment.
5. Follow a disciplined investment approach
Historically, it has been witnessed that even great bull runs have shown bouts of panic moments.
The volatility witnessed in the markets has inevitably made investors lose money despite in the great bull runs. Lot of investors, although successful in the short term, actually lose over the long term simply because they don’t follow a disciplined investment approach. However, the investors who put in money systematically, in the right shares and held on to their investments patiently have been seen generating outstanding returns. Hence, it is prudent to have patience and follow a disciplined investment approach besides keeping a long-term broad picture in mind. Remember that investment is a simple mechanical boring process.
6. Do not let emotions cloud your judgment
Many investors have been losing money in stock markets due to their inability to control emotions, particularly fear and greed. In a bull market, the lure of quick wealth is difficult to resist. Greed augments when investors hear stories of fabulous returns being made in the stock market in a short period of time. This leads them to speculate, invest in fancy mutual fund schemes of lesser known funds without really understanding the risk involved. Instead of creating wealth, these investors thus burn their fingers very badly the moment the sentiment in the market reverses. In a bear market, on the other hand, investors panic and sell their long held good mutual fund schemes at rock-bottom prices. Thus, fear and greed are the worst emotions to feel when investing, and it is better not to be guided by them.
7. Create a broad portfolio of funds
Almost 90% of portfolio variability is due to asset allocation while only 10% of the variability in portfolio performance is due to market timing and stock selection. The only thing in your control is asset allocation and the good news as written in lesson number 1 is that 90% of portfolio variability is due to asset allocation. Diversification of portfolio across asset classes and instruments is the key factor to earn optimum returns on investments with minimum risk. The reason for the relatively poor performance of portfolios of individual investors even in greatest of bull runs has been lots of variation in different schemes. There have been periods running into several months or years when the entire rally has been in equities or on other occasions by fixed income securities while sometimes by inflation hedges like gold. So, it becomes imperative to diversify your portfolio across various mutual fund schemes which provide you with such a diversification.
8. Have realistic expectations
There's nothing wrong with hoping for the 'best' from your mutual fund investments, but you could be heading for trouble if your financial goals are based on unrealistic assumptions. For instance, lots of equity funds have generated more than 50% returns during the great bull run of recent years or even debt fund returned in excess of 25% in times of substantial fall in interest rates. However, it doesn't mean that you should always expect the same kind of return from the markets. Have realistic expectations from your mutual fund investments – this in itself will ensure that you avoid a lot of common financial mistakes.
9. Invest only your surplus funds in high risk funds
If you want to take risk in by investing in high risk unknown funds, then see whether you have surplus funds which you can afford to lose. It is not necessary that you will lose money in them; your investments can give you huge gains too in the months to come. But no one can be hundred percent sure. That is why you will have to take risk. No need to say that invest only if you are flush with surplus funds.
10 Monitor rigorously
We are living in a global village. Any important event happening in any part of the world has an impact on our financial markets. Hence we need to constantly monitor our portfolio and keep affecting the desired changes in them. If you can't review your portfolio due to time constraint or lack of knowledge, then you should take the help of a good financial planner or someone who is capable of doing that. And while selecting a good broker or distributor don’t go after some high flying big name or market guru; instead opt for a person with common sense who considers himself as a student of investing.
To conclude, there are many simple and avoidable mistakes which we human beings as social animals succumb to at different levels of our dealing with money, be it at the time of earning, protecting, budgeting, saving, spending, leveraging, investing and insuring. Market is a place which will test your patience and character. Many times you might have bought the right stock or Mutual Fund for all the right reasons at the right price but it simply refuses to go up for a long period of time – just hang on to it because the day you get frustrated and sell it off, there are chances it will then start rising. Hence, patience and character are key virtues which will be repeatedly tested by the market. This article made a humble attempt to explain the 10 secrets of mutual fund investing.
Before I end this article, kindly note that simple logical things work far better in the market place rather than complex algorithms, theorems, valuations principles, DCF etc. And there is no other place to test your virtues than at the time of dealing with money – be it common sense, logical thinking, patience, perseverance, mental balance, emotional intelligence, performing under stress etc. All the qualities which make a successful human being will be tested by the market –it has its own method of finding and exploiting human weaknesses. Investing is not about beating the market or anybody else, its simply beating your own self, your own negative traits and once you are able to master your own self and become a complete human being, then only you would also become a successful investor. Articulate your investment goals, know your time horizon, recognize your risk appetite, understand your need for income and growth, invest regularly although it may be in small lots, do your thinking and research and after doing it don’t panic just because the market went against you, accept your mistakes and flaws and avoid the common mistakes which human beings commit while dealing with money and investing so as to embark on becoming your own a successful “money manager" and a complete human being.
Safe Investing and Happy honest Living!
The author’s first titled “10 Commandments for Financial Freedom” has just released. Details about the book can be found out at http://www.visionbooksindia.com/details.asp?isbn=8170948762
02 Dec - 10:00 hrs
Founder & CEO, Right Horizons