What are Mutual Funds?
Mutual Funds are the simplest investment instrument for an individual. Investors invest in a fund according to their ability. These funds are managed by the fund managers of different AMCs and allocate the assets under management.
The fund manager invests the collected corpus in purchasing securities from different companies. These may include, stock, bonds, shares, government securities, debts, and so on.
Mutual funds are associated with high risks and greater returns. One can earn either from the dividend obtained or capital gains. Investors can collect their dividends or invest them back to earn more due to compounding. In the long term financial goals, capital appreciation becomes handsome. The total capital gain is divided among the investors.
5 common mistakes to be avoided
While investing in a fund, we often encounter certain mistakes. Similarly, there are a lot of mistakes conducted by investors of mutual funds. Especially beginners tend to make more mistakes than experienced ones. But as the saying goes there is no age for learning and creating mistakes. The most common ones are –
- No proper goals and knowledge of risk-appetite
Before you start investing, you must focus on your financial needs. If you are investing in Equities, then you must know that the advantages are more in the long term financial goals. For a small time frame, you may receive low returns. Again, if you have started investing for the long term and suddenly you meet a financial crisis. Now you have the flexibility to withdraw the investment but with some penalties.
Another important factor is the risk appetite. Equities are highly risky while debts are for low risk-appetite investors. Now if you have a low monthly income and a low risk-appetite, but you have started investing in Equities, what will happen? You may not fulfil the requirements or may go bankrupt in the worst scenario.
- Depending on the past return records –
Most of the investors are said to check the previous year records for a particular fund. But you need to remember that a fund’s past performance cannot determine its future performance. These funds are highly exposed to market risks and therefore any fluctuation can affect their performance directly. A fund with good records doesn’t guarantee you handsome returns. But again it will show how the funds performed during market fluctuations.
It is therefore recommended to invest in more than one fund in the investment portfolio. Such that a loss generated from one fund can be balanced by the profit from another.
- No proper knowledge about the fund type –
SEBI has classified mutual funds into several classes. Some are highly risky, others may be ultra-low, low, or even at a mid-level. Then again there are Equity funds, debt funds, and hybrid funds. If you want to invest in several market caps then you have a multi-cap fund. Then again if you are willing to invest in a certain sector, then look for sectoral funds. Hence there are a plethora of options for you. But the most common mistake made by the investors is that they won’t check out the details of these funds and start investing as suggested by the fund manager. Your needs can be better understood by you. So why depend on the fund manager’s decision?
- Over diversification or A single fund –
Investors tend to over diversify their portfolio in the thought of earning more. Though portfolio diversification is highly recommended in mutual funds but going overboard can harm you adversely. It becomes difficult to manage too many funds. Moreover, the return curve flattens when you start investing in too many funds. If the majority of your funds starts underperforming then imagine how much loss you can encounter.
This doesn’t mean you will invest in a single fund. The reason is, you will encounter greater risks and the management of them becomes too difficult. Think of the fund you are investing in has encountered a sudden drop in price due to inflation. You will be badly affected and also can become bankrupt. So, invest in more than one fund such that the loss from one can be balanced by the profit from another.
- Focusing mainly on trading
Investors tend to sell their shares when the market is high to make greater returns. But to become a successful investor, you need to keep patience. Some of the investors go on purchasing and selling shares without considering the market conditions. Performing transactions in a hurry may lead to greater risks and huge losses.
At times, investors focus too much on saving taxes. Though it is one of the top priority of mutual funds. But focusing particularly on one point may create problems with the others. Instead, you need to focus on increasing your capital and earn handsome returns.
This investment tool gets an attractive tax deduction in the long term goals. Moreover, the entire portfolio is maintained by a professional manager. Therefore, being an investor you just need to worry about the collection of money. You can withdraw your investment but the company may charge you certain penalties. These get deducted from the dividends. Hence you get a less amount of return.
Mutual Funds can make you earn good with almost no labour, only if you are investing in the right way. For a beginner, it is sometimes okay to make mistakes as he/she can learn from them. This will make him/her experienced in this field. Every investment has its advantages and disadvantages. Therefore, understanding the entire investment procedure is necessary. If you are unable to understand then consult an expert for professional help.