If you take a wrong turn while driving, you would miss your destination and land up elsewhere. That’s a lot of fuel, time and effort wasted. Investing is no different. An investing mistake can send your financial plan astray. Mutual fund investors are prone to making mistakes — some minor, others quite serious. But all of them are injurious to their returns. Which of the following common investment blunders have you committed?
BLUNDER 1: Buying a fund because its nav is low
Which is cheaper: a 1 kg pack of sugar priced at Rs 20 or a 5 kg pack priced at Rs 100? Just as there is no difference between the two in terms of price, there is no difference between a fund priced at Rs 10 and one priced at Rs 50. High or low, a fund’s NAV at the time of purchase has no bearing on investors’ returns.It doesn’t matter whether you buy fund ABC which has an NAV of Rs 15 or fund XYZ which is priced at Rs 50. That’s because both funds will buy shares priced at the same level. It’s not as if ABC fund will get a discount because its NAV is low. Or that its NAV will not fall with the same intensity as XYZ if markets crash.Returns are defined by the performance of the shares bought by a fund. If your fund manager is good, he will pick potential winners and your fund’s NAV will rise. If he’s not so good, your fund will lag behind. Let’s assume that both funds do equally well. If the NAV of ABC fund rises to Rs 18 (a 20% gain), the NAV of XYZ would rise to Rs 60. The risks and the rewards are equal.
BLUNDER 2 : Buying and selling too often
Churn and you burn. Every time you buy an equity mutual fund, you pay an entry load of about 2.5%. That’s Rs 2,500 gone on an investment of Rs 1 lakh. Do that two times in a year and you lose Rs 5,000. A return of 25% a year gets pared down to 20%. Yet, many investors, goaded by agents and brokers looking to earn a fat commission from the transaction, don’t think twice before switching from one fund to another.The taxman too loves frequent selling for the money it brings to the exchequer in taxes. There is no tax on profits from equity mutual funds if the holding period is more than a year. But if you sell within a year of purchase, the profit is taxed at 10%. For instance, if you invest Rs 10,000 in an equity fund when it is at Rs 25 and sell it for Rs 40 a year later, you would not have to pay any tax on the Rs 6,000 profit.But if you sell it within a year of investment, you would have to pay capital gains tax of Rs 600 on the profit. In debt funds, long-term holding reduces the tax because of cost inflation indexation (see Query Corner page 20). But short-term gains are added to your annual income and get taxed at normal rates.
BLUNDER 3 : Investing and forgetting
If too much churning and short-term trading is bad for your portfolio, so is too much passivity. People just invest and forget. They don’t even remember the name of the scheme or the category they had invested in. They are just content in the knowledge that their money is growing. But is it? If you don’t monitor your investments, you may not know if your funds’ performance slips. We are not suggesting that you monitor your fund’s performance on a daily basis or take investing decisions based on short-term movements. But experts say that a quarterly or six monthly review is in order. Check out the returns from your funds in the past one year. If any of your funds has slackened, put it under the scanner. Compare its performance with its peer group in the category and against its stated benchmark index. If the weakness continues for two or three quarters, then there is something wrong and it would be better to exit the fund and switch to a better option.
BLUNDER 4 : Investing in lump sum, not systematically
Slow and steady wins the race. Sadly, this simple message is often lost on mutual fund investors. They invest huge amounts at one go and end up burning their hands when markets take a dip. Stock markets are inherently volatile.Systematic investments plans (SIPs) help investors make this volatility work for them. By investing at regular intervals, they average out their costs.In the example, if the investor took the SIP route, he would get 627.97 units at an average cost of Rs 19.10 per unit. However, if he invested Rs 12,000 at one go in May, he would have got only 600 units at Rs 20 per unit. Clearly, SIPs gave him a better deal.
BLUNDER 5 : Stop investing when markets dip
Anybody who started an SIP in any equity fund five years ago must be rolling in money. An SIP of Rs 5,000 started in the Reliance Growth Fund in July 2002 would be worth over Rs 13 lakh today. Even if the SIP was started in UTI MNC Fund—the worst performing equity scheme in the past five years—the investment would be worth over Rs 5 lakh. But many investors in mutual funds have not been as lucky.That’s because every time the markets went into correction mode, they stopped investing. SIPs were summarily terminated if there was a 200-300 point drop in the Sensex. Many even redeemed their equity funds, little realizing that the correction was actually an opportunity to buy more at low prices. The whole purpose of an SIP is defeated if the investor stops investing during market downturns. In effect, it means that he continued to buy when prices were high but stopped as soon as prices fell.
BLUNDER 6 : Investing in an NFO just because it is there
Imagine you are an HR manager and have to choose between two candidates. One is an experienced worker who is very good at his work. The other is a fresh graduate who sounds promising. Whom would you choose? The experienced guy, right?Thousands of Indians have done just the opposite. By investing in new funds that have no performance record to show, they have bet on the fresh graduate over the experienced worker. For instance, Reliance Equity Fund, the third largest diversified equity fund with assets of Rs 3,636 crore, was launched in March 2006.Of course, sometimes such wild bets strike it rich. Fidelity Equity, which was launched in April 2005, has outperformed the diversified equity category average of 47.17% by a wide margin by churning out returns of 60.39% in the past one year. Annualized returns of 49% since launch. One should invest in a new fund only if it offers something new in terms of exposure.For instance, the DSP Merrill Lynch Micro Cap Fund launched in May is mandated to invest in very small companies that may not even figure on the radar screen of most mutual funds. The fund is clearly aimed at investors who are capable of taking risks.
BLUNDER 7 : Diversifying too much or too little
Mutual funds are all about spreading your risks. About not keeping all your eggs in one basket. About diversification. But if you take this too far, it could well lead to diversification. There are investors who have over 15-20 funds in their portfolio. That’s okay if the portfolio is worth Rs 20-25 lakh. Not if it is Rs 1-2 lakh. That’s far too many baskets when you don’t have enough eggs.Too many funds means you end up duplicating the holdings and complicating your finances. Why have four or five large-cap funds when all of them will be investing in roughly the same stocks? It only adds clutter to your accounts — more folio numbers to keep track of, more dividend warrants, more additional investment cheques. More paperwork. More Saridon.
Too few funds could also be bad. Just one or two funds may not be sufficient to spread the risk. Invest in a bouquet of 6-7 funds of different investment styles. Also, don’t confine yourself to just one fund house. Invest in at least 2-3 different AMCs.
Source: Money Today
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