Avoid These Mutual Fund Investing Traps

Mainly aided by the explosive growth in SIP’s (Systematic Investment Plans), the Indian Mutual Fund industry has registered an explosive growth in the past few. There are, however, a common set of traps that Mutual Fund investors (seasoned and new alike) keep falling into. Here are the top five that you need to avoid at all costs.

The “Short Term Lens” trap

Does your “fund selection” methodology entail sorting various schemes by 1-year returns, and jumping in with both feet? You’re bound to feel the heat sooner than later. The reason why this is a deeply flawed technique is quite simple to understand: all asset prices go through cycles. If you only invest based on high short-term past returns, you’ll always buy into asset classes at the wrong point in their cycles. Quit employing this oversimplified approach towards portfolio building. With the NIFTY soaring to new heights and many market segments such as small and mid-caps having doubled from their COVID panic-induced troughs of 2020, this is especially relevant right now. Remember, the reverse applies too – if the one-year return from a particular fund is -25%, it may very well be at a point where investing in it can reap rewards over the next few years. But if you view this as a negative, you’ll shy away from it.

The “Action” trap

It’s common for NAV’s of all Mutual Funds to fluctuate or even stay stagnant for frustratingly long periods. If you grow impatient and start moving things around every time asset prices fluctuate, you’ll not only end up bearing high transaction costs and taxes – you’ll also continually miss out on the high return phases that would have otherwise accounted for the lion’s share of your wealth creation from these funds. Review often, but don’t be in a hurry to chop and change things unless there are drastic changes in underlying fundamentals that drove your investment decision. Once a year is a plenty when it comes to reviewing your portfolio.

The “Ignorance” trap

Can’t tell credit risk from interest rate risk? Unaware of how dynamic asset allocation funds work? Unclear about the potential upsides and downsides of small-cap funds? You’re in for some severe heartache. Mutual Funds may be ‘shut and forget’ investment vehicles to an extent – but that doesn’t absolve you from your duty to understand their basic concepts and the risks associated with them. Make sure you aim for an above-average awareness of how various types of Mutual Funds really work, and what drives their returns (or lack of returns!)

The “Scatter” trap

Do you compulsively invest into NFO’s? Do you insist on investing little sums of money in every Mutual Fund scheme that catches your fancy? You’ll likely end up over diversifying your portfolio to the extent that you cancel out most of the ‘alpha’ or outperformance that you could have achieved. The most effective portfolios are compact, well-organized and consisting of no more than 5-10 schemes. Don’t scatter yourself across a multitude of funds.

The “Tax Efficiency is everything” trap

While the tax efficiency of your returns is undoubtedly a worthy consideration, making it the sole driver of your investment decisions is a poor decision. For example, you may be a retired investor who can afford to take very little risk, but you invest purely in inequities because they’re more tax-efficient than debt funds. Or – you choose not to take profits at the obvious peak of a bull market cycle, simply because you’d like to avoid booking capital gains. This is nothing but missing the woods for the trees.