Mutual funds could be a good investment fit for different types of investors. They are often the preferred investment vehicle for first-timers and experts alike, irrespective of their asset class preferences and risk appetites. People usually invest in mutual fund schemes because these are easy to understand, transparent, carry the potential to generate desired returns and don’t require them to be an expert when they start investing. However, that doesn’t mean you should invest in a mutual fund without any knowledge about what you are doing. Unmindful and thoughtless investing in mutual funds could easily result in serious mistakes that can ruin your investment goals.
Here are some crucial points that can help you avoid committing big mistakes when you are starting your mutual fund investment journey.
- Investing Without Considering Your Return Expectations And Risk Appetite
It can be a big mistake to invest blindly based on recommendations that may not be aligned with your return expectations or risk appetite. For example, let’s suppose you require ROI of 9% p.a. to accomplish your financial goal – something you can easily do without taking much risk. However, somebody recommended you to invest in a mutual fund scheme that can give you a return of around 16% p.a. but also carries a higher risk. In this case, you may commit a mistake if you ignore your actual return requirement and take unnecessary risk.
As such, your investment in mutual funds should be strictly aligned with your financial goal requirements. Depending on the time in hand to achieve a particular goal and its size, you may decide your return requirement. Accordingly, you may choose a mutual fund product that suits your risk profile for attaining the goal.
- Investing In A Lump sum And Not Through SIPs
Which is better, lump-sum investment in mutual funds or systematic investment plans (SIP)? A lump-sum investment can be a good option if you’re looking for low-risk and low-returns through a debt scheme. Investing a lump sum in an equity fund can be risky. On the other hand, if you invest through SIPs, it can significantly reduce the volatility risk, allow you to benefit from rupee-cost-averaging, and offer you attractive returns in the long-term.
You may also convert your lump sum investment into a staggered one. You can invest lump sum in a debt fund and select for a systematic transfer plan (STP) to invest in equity fund SIPs. This way, you can ensure regular returns on your lump-sum fund and gradually shift to an equity scheme if doing so is aligned with your risk appetite.
- Investing In Sectoral Funds Without The Required Knowhow
When you start investing in mutual funds, the best way is to diversify your investments to lower the overall risk. You may choose different asset classes, different sectors within the same asset class, and different instruments. Now, sectoral equity funds focus on a particular industry or sector, and therefore they lack diversification. If the underlying sector performs poorly, your fund value will also go down. So, once you get accustomed to the equity market and have expert knowledge of a particular sector, you may invest a small portion of your fund into sectoral funds. For new investors who do not have the required knowhow, investing in sectoral funds could be highly risky.
- Investing Without Understanding The Basics Of Mutual Fund Products
Different mutual fund schemes may carry different charges such as expense ratio, exit load, etc. They may also vary in terms of tax treatment. For example, if you exit a debt fund before three years, any gain thereof is considered a short-term capital gains (STCG) while gains booked after three years are called long term capital gains (LTCG). The STCG under a debt fund is taxed at the slab rate applicable to the investor, whereas LTCG is taxed at a 20% rate (with indexation benefit). Similarly, the tax calculation in equity mutual funds is different. There are tax-saving funds called equity-linked savings schemes (ELSS) which come with a lock-in period of three years. Then, there is an option in mutual funds to reinvest the dividend called the growth option, whereas you can also opt for regular dividend pay-outs.
So, it’s vital to learn the basics of mutual fund products pertaining to tax applicability, charges, type of funds, liquidity, etc., before you start investing your hard-earned money. Any lack of knowledge regarding these could attract adverse outcomes. You’ll be well-advised to research on these topics or seek help from a certified investment planner to make informed investment decisions.
- Continuing With High-risk Funds After Building The Target Corpus
The purpose of any investment should be to achieve the desired level of corpus within a defined period in sync with your risk profile and liquidity requirements. But let’s suppose your mutual fund investment generated a higher return than what you had expected and you successfully built the desired corpus well before the target tenure. In this case, you should not commit the mistake of continuing with the high-risk fund; instead, you should book profits and shift your corpus to a lower risk mutual fund scheme to eliminate the chances of losses during the remaining period.
The writer is CEO, BankBazaar.com, India’s leading online marketplace for loans and credit cards.