The current bull run in the stock market and declining returns from fixed deposits and real estate is attracting retail fund investors like never before. Here are seven ‘investing don’ts’ for mutual funds.
Comparing NAVs to select funds
Many investors select funds on the basis of the Net Asset Value (NAVs) as they consider funds with lower NAVs as cheaper. The myth of low NAV is also used by advisors and distributors to pitch New Fund Offers as their units are issued at the face value of Rs 10. However, NAV is per unit value arrived at after dividing the total value of the fund portfolio by its total outstanding units. Instead of using NAV as a selection parameter, use funds’ performances along with their future prospects of beating their benchmark indices and peer funds to select mutual funds.
Ignoring risk appetite
Your risk appetite depends on your liquidity, cash flows and investment horizon of your financial goal. However, many investors fail to factor them in their pursuit of returns, especially during bull markets. This leads them to invest in equity funds even for short-term goals. Any significant reversal in the equity markets forces them to either book losses fearing further capital erosion or take expensive loans to fulfil their financial goals.
Getting carried away by emotions
Greed leads investors to increase investments in bull markets when high valuations should be a cause of concern. Again, market corrections scare them even though equities are available at attractive valuations. Instead of letting these emotions cloud your decisions, go for a suitable asset-allocation strategy. Use SIPs to invest in equity funds and create a ‘market-crash fund’ to invest lumpsum during market corrections.
Compromising your liquidity
Bull market phases tempt many to channel their entire surplus into equity funds. However, a financial emergency during market corrections may force you to either redeem your existing equity investments at a loss or take expensive loans from banks. So, invest in equity funds only after making sufficient allocations for your emergency fund and various short-term goals.
Performance during buy/ sell
Many investors consider the fund’s recent performance, especially its last one-year returns, to buy or redeem investments. However, such short-term under- or outperformance might result from a few stock picks, which may not continue in the long term. Remember that even good funds can underperform due to the fund management style and market conditions. For example, value funds usually underperform growth funds during bull markets.
Thus, while selecting an equity mutual fund, compare its past performance with its peer funds and benchmark indices for the last five-year and if possible, for 10-year period. The 10-year period will give you a clear idea about the fund’s performance over an entire economic cycle. Sell your existing funds only if they have under-performed their peer funds and benchmark indices for three to four consecutive quarters.
Over-diversifying makes it cumbersome to track and bring down its overall returns. Moreover, over-diversifying within the same asset class or fund category does not make much sense as the constituent units would move in the same direction, i.e, down, during market corrections. The best way to deal with such corrections is to hold and buy more.
Timing your investments
Successful timing of markets is difficult as you need to be right twice. Not only do you need to accurately predict the market highs and come out of it, you also need to predict the market lows to jump back in. Since sustained bull markets can last longer than bearish periods, surpluses will idle in low risk-low return fixed income products for a long period. Worse, it can lead to missed opportunities. Instead, try to stay invested for longer periods. Go for SIP mode as it ensures financial discipline through regular investments and cost averaging during market dips and corrections. For higher returns, invest lumpsum in those schemes during significant dips and corrections.
Manish Kothari – The writer is director, Investments,