Imagine saving for a special purchase. You invest your savings month by month, year by year. And when the time of tallying your savings comes, you get to know you did the whole investment thing wrong!
Do not fall into such rattraps.
Do you know that only 31% of Indian Investors are likely to consider using Mutual Funds as a means of Investment? (Times of India). Mutual Funds one of the easiest and widely used investment methods used by small and medium investors alike. Investing in mutual funds requires informed decisions. Are you informed?
In this article, we will discuss some common mistakes investors make when choosing mutual funds and how to avoid them. Make sure to steer clear of these mistakes, and set your eyes on the prize. Ready to play smooth and safe?
Most common mistakes while choosing Mutual Funds
Here are some of the most commonly made mistakes that investors fall prey to while selecting Mutual Funds.
1. Zero or minimal research:
One of the biggest mistakes investors make is not conducting proper research before investing in mutual funds. Many people simply rely on recommendations from friends or family members, without understanding the underlying investment strategy or the fund's track record.
It is crucial to research in-depth about the mutual fund you are considering. This includes its investment objective, past performance, and the qualifications of the fund manager. Research helps you make informed decisions and choose funds that align with your financial goals. Take care that your research should not be limited to Mutual Funds. Market research plays an equally important role. Market Fluctuations, ROI on each type of fund, Market Risk are more such factors one should be considering while choosing the right Mutual Fund.
2. Not reading rules and regulations of each fund:
Every mutual fund has its own set of rules and regulations that govern how the fund operates.
Some common regulations associated with Mutual Funds include- the requirement to register with regulatory bodies such as the Securities and Exchange Commission (SEC) and complying with disclosure requirements, including providing prospectuses and annual reports to investors. Mutual funds must also adhere to restrictions on investment strategies and diversification, ensuring that they do not concentrate their assets in a single security or sector. These funds set rules for valuing their assets and calculating net asset value (NAV), fees and charges to investors it is very important to read and understand these rules before investing
According to a survey, about 77% of investors fail to read the entire T&C which, surprising enough, includes high profile investors as well. Be fully aware of what you are getting into and avoid any surprises down the line!
3. Underestimating the impact of fees:
Mutual funds come with various fees and expenses, such as management fees, administrative fees, and sales charges.
These fees can subtract your returns over time. While it can be tempting to choose the lowest-cost fund, it’s also important to consider a fund’s performance and growth. A fund with slightly higher fees but a strong track record can be a better investment in the long run. These funds generally have experienced fund managers who actively select investments based on their research and expertise. Popular mutual funds include Vanguard, Fidelity and Aditya Birla.
Some of the common fees in Mutual Funds are-
Expense Ratio: This is the annual fee charged by the mutual fund company to cover operating expenses. It is expressed as a percentage of the fund's average net assets.
Front-end Load: Some mutual funds charge a front-end load, which is a commission or sales charge paid when purchasing shares.
Back-end Load: Also known as a redemption fee or deferred sales charge, this fee is paid when selling shares of a mutual fund. It is usually a percentage of the amount being redeemed and decreases over time.
12b-1 Fee: This fee is named after the Securities and Exchange Commission (SEC) rule that allows mutual funds to deduct a percentage of their assets annually to cover distribution and marketing expenses. It is included in the expense ratio.
Management Fee: This fee is paid to the fund manager for managing the fund's portfolio.
Transaction Fee: Some mutual fund companies charge a fee for buying or selling shares, especially for funds held outside of the fund company's own brokerage platform.
4. Not considering future effects/returns:
When selecting mutual funds, it is important to consider the potential future effects and returns of the fund.
Let's consider a hypothetical mutual fund that has consistently delivered an average annual return of 8% over the past 10 years. Based on this historical performance, an investor might reasonably expect the fund to continue generating similar returns in the future.
The future profitability of your mutual fund depends on many factors such as the fund’s investment strategy, historical performance, market conditions and the expertise of the fund manager
By considering future impact and returns, you can make safer investment decisions and choose investments that can provide long-term returns.
5. Investing in many similar funds at the same time:
Diversification is an important principle of investing, but investing in too many similar funds can actually reduce the benefits of diversification.
Many investors make the mistake of investing in multiple funds that have similar investment objectives or holdings. Best case scenario, it works out good. Worst case, this can lead to overexposure to certain sectors or asset classes, increasing the risk of your portfolio. Instead, one should focus on selecting some well-diversified funds that complement each other without harming your investments.
Do we have any alternatives?
Yes. Mutual Funds have proven to be a popular choice amongst the investors. But there are other options with unique benefits you might want to consider:
Individual Stocks:
Exchange-Traded Funds (ETFs):
Index Funds:
Real Estate Investment Trusts (REITs):
Bonds:
Certificate of Deposit (CD):
Final Takeaway
Investing in mutual funds can be a fruitful way to increase your savings. But, it is obviously important to avoid common mistakes when choosing a fund. By proper research, you can increase your chances of achieving your financial goals by choosing the right mutual fund.
“ In the long run, a portfolio of well chosen stocks and/or equity mutual funds will always outperform a portfolio of bonds or a money-market account. In the long run, a portfolio of poorly chosen stocks won't outperform the money left under the mattress.” - Peter Lynch
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