Choosing the right mutual fund is more than just selecting the top-performing funds. Time and again, many investors fall into avoidable traps, such as opting for funds based on social media tips or selecting funds purely based on their recent performances.
Understanding such common mistakes is crucial for building a healthy, goal-aligned portfolio. Focus should be on selecting a reputable mutual fund after proper background checks.
Here are five common mistakes investors make while selecting mutual funds:
1. Investing without clear objectives
Many investors initiate their mutual fund investment journeys without proper goal setting and due diligence. The focus should be on understanding the associated risk with investing in any particular mutual fund. Fundamental objectives such as marriage, child education, retirement, or buying a new home should guide both the fund selection task and investment horizon. Such planning can help in better management of resources and Systematic Investment Plan (SIP) planning.
2. Chasing past performance
A fund that performed well yesterday won’t necessarily deliver exceptional returns tomorrow. Past returns are no direction or guarantee of future performance. That is why investors who base their investment decisions solely on historic returns ignore the role of consistency, strategy, forward-looking decision making, and proper analysis of risk profiles. All such factors must be taken into account before investing in any particular mutual fund.
3. Ignoring costs and fees
The expense ratio of a mutual fund and hidden charges are factors that should always be kept in mind by aspirational investors. Management, transaction, or distribution fees can all cumulatively reduce returns over time if attention is not paid. Even minor differences can compound into significant fees as the years roll on.
4. Emotional decisions and market timing
Permitting market sentiment to dictate your investment decisions is not an extremely sensible idea. Selling mutual fund units in an economic downturn or buying units during euphoria immensely undermines long-term compounding of wealth. Investments in mutual funds should be made based on logic and sensible planning, not on pure emotions.
5. Lack of diversification or style drift
Focusing heavily on sectoral or thematic mutual funds exposes portfolios to volatility. Similarly problematic is ‘style drift,’ i.e., a situation where funds stray from their stated investment ideologies and expose the investments to higher risk in exchange for better returns. To combat such situations, investors should diversify their investments across different asset classes such as equities, real estate, fixed deposits, and gold.
In conclusion, on a fundamental level, investments in mutual funds, irrespective of large, mid, or small-caps, carry varying risks and the possibility of underperformance. Still, decisions on opting for any particular fund should be made after proper consultation with a certified financial advisor.
Disclaimer: Mutual fund investments are subject to market risks and may fluctuate in value. Investors should read all scheme-related documents carefully and consult a certified financial advisor before investing.