5 most common mistakes that first-time MF investors make

Naveen Kukreja The advent of online investment platforms and eKYC has eased mutual fund investing for beginners. This ease is encouraging many first-time investors to take a DIY (Do-It-Yourself) approach rather than depending on financial advisors for expert advice. However, the lack of understanding about mutual funds and capital markets leads many to take wrong investment decisions. Here are some of the common mistakes that first-time fund investors often make. Hunting for low NAV funds: Financial advisors and mutual fund distributors often use the myth of ‘low NAV’ to pitch new fund offers (NFOs). By equating the concept of mutual fund NAV with that of share prices, they convince the investors that low NAV funds are cheaper. However, this is not true. NAV of a fund is determined by the value of its underlying assets and the total number of its outstanding units, and it can be high or low due to various reasons. A relatively new fund will have a lower NAV while an old fund with excellent performance over the years will have a very high NAV. Similarly, the NAV of better performing fund will increase faster than a ‘not-so-good’ fund over the same time period. Instead of NAV, you should rather consider a fund’s past performance along with its future potential to deliver high returns. For example, assume that you have an option of buying either of two mutual funds. Fund A, which has an NAV of Rs 25, has delivered an annualized return of 12 percent p.a. Fund B, having an NAV of Rs 15, has delivered an annualized return of 8 percent p.a. So, which mutual fund should you prefer? Obviously, the mutual fund delivering higher returns. Thus, never use a fund’s NAV as a criterion to buy mutual funds. Investing in mutual funds to earn dividend: Some distributors project dividend as some sort of a windfall or bonus earnings. However, what these advisors don’t disclose is that the dividend is paid out of your own investment only. As soon the mutual fund scheme pays dividend, the NAV of that scheme gets reduced by the amount of the dividend paid. For example, assume that a scheme with NAV of Rs 60 declares a 20 percent dividend. As soon as the scheme pays you the Rs 2 (20 percent of face value) dividend, the NAV of that scheme will come down to Rs 58. In effect, the mutual fund pays back your own money. Instead, opt for the growth option to benefit from the power of compounding.Ignoring the investment objectives of mutual funds: Investment objective of a mutual fund determines the type of stocks and other securities that a fund manager may decide to invest in. This helps in giving you a fair idea about how the scheme proposes to manage your investment. Ignoring a fund’s investment objective may land you with a wrong fund for your financial goals.Over-expectation from equity mutual funds: Most first-time investors start with unrealistic expectations from equity mutual funds, especially during bull markets. However, returns generated during bull market are not sustainable in the long term. This leads many to liquidate their mutual fund investments during market corrections or bearish market phases. Instead, follow a proper asset allocation strategy to achieve your financial goals. As equity mutual funds are susceptible to market volatility, invest in equity mutual funds only if your investment goals are 5 years away or more. For goals maturing in 3–5 years, invest in hybrid mutual funds. Invest in liquid funds and debt funds for goals maturing within 3 months and 3 months–3 year, respectively. Not diversifying enough: Many first-time investors of mutual funds invest their entire investible surplus in just one mutual fund. However, instead of putting all eggs in one basket, diversify your investments by investing in schemes of different fund houses. Thus, even if a particular scheme underperforms its benchmark index or peer funds, your investments in other schemes may save the day for you by providing higher returns.Making mistakes and learning from them are an integral part of one’s learning curve. However, while wise men learn from their own mistakes, wiser ones learn from others’. Thus, apprising yourself of these common mistakes will save you from repeating them. Identify the time period required for achieving your financial goals and invest in various asset classes, accordingly. Diversify across two or three schemes to reduce your fund manager’s risk and do not get swayed away by dividends and low/high NAVs while choosing your mutual funds. The writer is CEO & Co-founder of Paisabazaar.com