I am writing this post after receiving so many doubts and questions related mutual fund investments. The Mutual Fund Investors in India commit so many mistakes which they never notice them as mistakes. Hence, I thought to list them in detail.
# Invest because of peer comparison
Recently I received a mail from a reader that his friend has invested in equity mutual funds since 5 years. Returns are around 20%. His friend showed his fascinating investment history to this guy. Therefore, now he is also very much eager to invest in mutual funds (specifically in equity mutual funds) where his friend invested.
But he does not know why his friend investing, what is his risk taking capacity, what prompted him to invest in equity mutual funds since 5 years and whether his style suitable to him or not. A blind following and starting of investing in equity mutual funds or in any product.
Such type of investment is called as decisions based on peer comparison. We never understand what is best for us. But we compare our friends, relatives or colleagues and jump into investing.
It is such a dangerous mistake, which many Mutual Fund Investors in India unable to understand. I tried to represent such acts in below image.
# No specific financial goals set
First, I receive queries regarding which product to invest. They need a specific product name from me. However, when I question them about the time horizon of the goal, then their answer is so random that it scares me to suggest anything.
The tenure of their financial goals is like 5-10 or 15-20 years away from today. But sadly they don’t know that there is a BIG 5-year gap in their assumptions of goals.
It is hard to suggest or guide anyone who don’t know the exact tenure of their financial goals. However, in a few cases, I can understand that we have to assume but can’t specify perfectly. But what if all goals are so random.
# Attraction towards short term equity returns
Just observe the below image.
Here, I took HDFC Top 200 as an example. Because it is in the market since 3rd September, 1996. You notice that returns of 3 months are shown as 16.88% and 6 months as 30.5%, which is very, very impressive than the returns of 5 years (14.46%), 7 years (13.58%) and 10 years (14.57%).
Six months returns showing 30.5% returns. Which product in India gives us 30% returns for 6 months of investment? So we MUST invest in HDFC Top 200 Fund, am I right?
Hold on….this is where many of us make mistakes. We forget the first thumb rule that equity investment is for long term (in my view if your goal is 5+ years). The second mistake what we do is eye-catching short term returns. So we jump and invest in such equity funds with an expectation of around 30% for 6 months of investment.
We assume that equity is not good for the long term. But definitely best products for the short term. However, the reverse is true. When you assume a 30% return for 6 months of investment, you must be ready to expect the negative return of 30% also. Are you ready? If so, then go ahead. Either you receive +30% or -30%. Sadly we fail to understand the risk and volatility in such short-term equity market.
Note-Less than a year returns are absolute returns and more than a year returns are expressed in CAGR.
# Holding too many funds or too less funds
I noticed that a few have 1-2 financial goals. But holding 10-15 equity funds. But at the same time, few holding only one equity fund like sector funds. I am not against the person who hold a single fund like an equity-oriented balanced fund, which gives you enough exposure to debt and equity. However, I found that few are holding sector funds as they are very much optimistic about the particular sector. But they forget that any negatives about particular sector means they must be ready to bear the heat of negative returns or loss in their portfolio.
Holding too many funds create overlapping. At the same time, holding a single fund for the sake of fancy returns is also not good.
# No proper Asset Allocation
In 99% of mutual fund investors, I found no proper asset allocation. It is may be due to illiteracy towards investment or scarcity of proper guidance. I found that many investors investing 100% of their investable surplus in equity. Because their goals are long term. Hence, why to satisfy for less by investing in other asset class (like debt).
During the period of the bull run, all experts or funds give you positive news. However, the real test will be when there is a downtrend in the market or free fall in the market. During such falling market, the asset allocation will protect you.
If you have the proper debt to equity exposure based on your timeframe of goal, then it is always the best investment strategy.
# No proper expectation from investment
Everyone running behind BEST returns. But they don’t know or hard to fail to define what is BEST return. For me, it may be 10%, for others best returns means 30%. First, you must define your expected return from your investment. Also, such expected return must not be any fancy number. It must be realistic. For example, from equity, you can expect a 12% return (for long term goals) and from the debt, it may be around 7%.
If your funds are generating the expected return, then you no need to worry about other funds star ratings or returns. Because you are getting what you are expecting. So why to worry??
# Debt Funds are safe but equity funds are unsafe
It is the biggest mistake many investors believe and start to invest in debt funds like Income Funds or Long Term Gilt Funds. However, while selecting debt funds, you must concentrate on two aspects.
- Modified Duration-It is measured in years. It is the measurement of interest rate sensitivity of a fund. Let us say, if the modified duration of a fund is say 4 years, then for every 1% interest rate movement, the bond price may move 4%. Higher the modified duration means higher the volatility.
- Average Maturity-This means the average maturity period of a portfolio of all bond papers the fund is holding. The higher the average maturity, higher will be the interest rate risk.
So you must understand the risk involved in debt funds. Funds like Income Funds or Gilt Funds are riskier than Short Term, Ultra-Short Term or Liquid Funds.
However, it does not mean that Short Term or Ultra Short Term Funds are safest. But the volatility will be lesser. We may easily compare the volatility of Liquid Fund to Income Fund from below images.
I selected above fund because I can show you the return movement of long term. Because this fund was launched in the year of 2001.
See the return lines of Birla Sun Life Gilt Fund. Compare this volatility with the liquid fund volatility. You notice the difference. Below is the modifified duration and average maturity of both liquid fund and income fund.
Modified Duration of Reliance Liquid Fund-Cash Plan-0.11 Vs Modified Duration of Birla Sunlife Gilt Fund-8.33.
Average Maturity of Reliance Liquid Fund-Cash Plan-0.12 Vs Average Maturity of Birla Sunlife Gilt Fund-15.91.
Hence, if you have enough equity exposure, then try to restrict your investment to short-term or ultra short-term debts or to the maximum of Gilt Short Term. But don’t go beyond that.
Recently, I came across this below eye catching advertisement about Liquid Funds.
This is something called weekend investment. Seems to be eye catching. Such returns may or may not be possible. However, the advertisement perfectly shows how much returns you will generate. Liquid funds over a year may generate 9% or less than your savings account also. The above advertisement not explaining of on what basis they arrived at this final value. So never ever believe on any one. Especially if someone claiming GAURANTEED returns from mutual funds (whether it is debt funds or equity funds).