Making mistakes is a part of life. However, some mistakes can cost us dearly, especially if they are financial as they can have a long-term impact on our finances.
Making mistakes is a part of life. We all make them. However, some mistakes can cost us dearly, especially if they are financial as they can have a long-term impact on our finances. The quality of our financial lives is largely determined by the investment choices we make. Here are the 5 most common mistakes people make while investing their money:
1. Mixing insurance with investment: First and foremost, insurance is not an investment to grow your money. Insurance is an assurance that takes care of you and your family when hit by unforeseen circumstances, like an untimely death or a medical emergency.
Term insurance, for example, is a must for every earning individual. Buying a term insurance plan is the best way to get yourself adequately covered as you can get the ideal cover of at least 10-15 times of your annual income at very low premiums. For instance, a 30-year old can buy a 30-year life cover of Rs 1 crore for annual premium of just Rs 8,000-10,000.
However, most investors confuse insurance as an investment instrument and instead invest in endowment or money back policies which neither provide adequate cover nor generate optimal returns.
Hence, avail term plans to adequately cover yourself at low premiums and invest in ELSS and other mutual funds for meeting your financial goals based on your tax liability, risk appetite and investment horizon. Similarly, invest in a good health plan to avoid high healthcare expenses that can impact your savings.
2. Investing without identifying financial goals: Financial goals are monetary expressions of your life goals – i.e. things you wish to achieve in future. Like buying a house, car, sending your child abroad for higher studies, and having a comfortable retired life etc.
With financial goals in place, you will get a clear idea of how much you need to save and invest to achieve those goals. Setting financial goals also help in achieving a better asset allocation based on your time horizon and risk appetite. For example, equities can be very volatile in the short term and hence, not advisable for meeting short-term goals, like planning a vacation next year. Instead, fixed deposits and short term debt funds should be preferred as they carry nil to very low risk of capital erosion.
Similarly, since equity are most likely to generate the best returns in the long run, they are ideal for your long-term goals that are more than five years away, like saving for your child’s higher education or marriage.
3. Not creating a post-retirement corpus: Most investors consider retirement planning to be a distant goal and hence, do not start investing for it until they reach their late 40s. Others tend to solely depend on their EPF or PPF contributions, which are likely to be too small to create an adequate post retirement corpus. Ensure you start as early as possible and choose the right investment instrument to create a big retirement corpus to live a worry-free retired life.
Start by using online retirement calculators to find out your ideal post-retirement corpus and the monthly contribution required to create that corpus. As equities beat inflation and other asset classes by a wide margin, invest in equity mutual funds to build your post-retirement corpus. Take the SIP mode of investing for to ensure regular investing and cost averaging. And lastly, start your retirement contribution at an early age to maximize your benefit from the power of compounding.
4. Factoring NAV while choosing mutual funds: Mutual fund investors, especially beginners, fall prey to certain wrong practices and myths. Chief of them is factoring NAV while choosing funds. They wrongly believe or are convinced that a fund with a lower NAV or an NFO (New Fund Offer) is cheaper than others. However, the NAV of a fund can be high or low due to various reasons. For example, the NAV of a better-performing fund will always grow faster than poor performing funds. Similarly, a newer fund will have a lower NAV than its much older peers as it got lesser time to grow.
Hence, never use funds’ NAVs to select your fund. Instead, compare their past performances and future prospect of beating their peer funds and benchmark indices.
5. Selecting mutual funds on the basis of their dividend history: Many investors buy mutual funds just to earn dividends. They consider mutual fund dividends as some sort of a windfall income. However, what they do not realise is that the mutual fund dividends are paid out of their own investment. As soon as a mutual fund pays its dividends, it’s NAV gets reduced by the dividend amount. For example, if a scheme with an NAV of Rs 20 declares a 10% dividend, it will pay a dividend amount of Re 1 (10% of Rs 10 face value) per unit and its NAV will come down to Rs 19 after the dividend record date.
Instead of opting for the dividend option, opt for the growth option to benefit from the power of compounding. However, if you are looking for consistent cash inflows from your mutual fund investment, then opt for the SWP (Systematic Withdrawal Plan) option. Under this option, a pre-determined amount will be periodically redeemed from your mutual fund scheme on pre-determined dates and the proceeds will be credited to your savings account.
(By Manish Kothari, Director & Head of Mutual Funds, Paisabazaar.com)