Mistakes Mutual Fund Investors Commit

Mutual fund investments in India has been on an upward splurge in recent years. The AUM as on June 30th, 2019 stood at Rs 24.25 trillion. Precisely ten years back, on June 30th, 2009, the AUM stood at Rs 5.83 trillion. The growth in AUM since 2009 is more than four-folds. Increasing investments in the MF industry is quite overwhelming, and with investors being more sanguine about the market, this number is expected to go up.

A wave of volatility hit Indian markets last year due to multiple incidents in the market. The small and mid-cap funds being the biggest losers in the equity segment. The debt market witnessed a few defaults shaking investor confidence, leading to a significant amount of outflows from the MF industry.

With the volatility tides receding, it’s imperative for the investors to take a step back and rethink their investment decisions. Here are a few common investor mistakes in the mutual fund industry that are often not recognized by the investors.

Investing in dividend options

Dividends are paid out of the NAV of the fund. Once the dividend is paid, the NAV reduces by that extent. Dividends are subject to Dividend Distribution Tax of 10%, and in the short term the capital gains tax is 15%, and in the long term, the capital gains tax is 10% if the gains exceed Rs 1 lakh. It’s always better to go for growth options instead.

If one still wants regular income from their mutual funds, it’s better to opt for SWP plans instead. Dividend payments are done at the discretion of the fund house and are highly dependent on the performance of the fund. If the fund is paying high and consistent dividends, it won’t be able to guarantee the same few years down the lane. Instead, choose SWP plans which give regular income and have lesser tax than dividend options.

No diversification or over-diversification

Investments aren’t immune to market risk. Volatility in the market has led the market to higher highs but also lower lows. Having a balanced portfolio will help hedge the risk during market lows. Diversification is the key to reducing risk in a portfolio. One cannot invest in one or two mutual funds and think the risk is covered. Now one cannot invest in 10 different funds in the name of diversification. A maximum of 5 mutual funds in a portfolio is considered ideal for equity mutual funds spread across multiple segments and categories.

Timing the market

Mutual fund investors are supposed to have a goal and a target and invest throughout their investment tenure. Abandoning an investment mid-way or pausing it or redeeming it due to the anticipation of a market correction is a blunder. Experts always say not to time the market when investing through mutual funds. The best time to enter the market is anytime when one is doing a SIP. The only key for SIP to work is a continuous investment for the long term. Instead of concentrating on timing the market concentrate on the time one stay in the market.

Let’s take an example of a SIP investment of Rs 5,000 for a tenure of 120 months (10 years). If the person continued investing regularly, then the corpus accumulated at the end of the period is Rs 13.93 lakhs and if the person timed the market and paused the SIPs for few months at a time (96 months). Then the corpus accumulated at maturity is Rs 9.29 lakhs. Even though the investment tenure is the same, due to pausing the SIPs, the difference is corpus is around Rs 4.63 lakhs.

SIP Tenure MonthsSIP Amount (rs)Total Investment (Rs)Maturity Corpus (Rs)
12050006 lakhs13.93 lakhs
9650004.8 lakhs9.29 lakhs

Shifting to direct plans

Direct plans are less costly than regular plans and hence give a slightly higher return. To earn more profit, one should opt for direct plans over regular ones.

Fund NameExpense Ratio Return (5 Years)
SBI Small Cap FundDirect: 1.23%
Regular: 2.38%
Direct: 22.27%
Regular: 20.77%
Mirae Asset Emerging Bluechip FundDirect: 0.79%
Regular: 1.99%
Direct: 20.97%
Regular: 19.94%
Motilal Oswal Multicap 35 FundDirect: 0.96%
Regular: 1.86%
Direct: 18.20%
Regular: 17.07%

However, direct plans lack the most important thing. They lack continuous monitoring. One cannot invest in a mutual fund and sit idle till the target investment tenure. Reviewing and rebalancing of the portfolio from time to time is very important to check the progress of the investments. Opting a direct plan over a regular plan can be disastrous when the investor lack market knowledge. There are many DIY investors, and it’s good that they can save extra money and earn an excess return. But they also have to do extra work on continuous monitoring of their portfolio, which is done by advisors in the case of regular funds. The advisors charge an additional of 80-90 bps extra for all the services they provide, which include expert advice, continuous monitoring, and rebalancing of the portfolio if needed.

Investing in high yielding debt funds

Debt funds are a safe play. The entire concept of investing in debt funds come to earn a decent return with less risk. There is no point of chasing returns in debt funds. Debt funds provide the needed diversification in a portfolio. It’s better to opt for debt funds which invest in highly rated securities that give a 7-8.5% return than investing in low rated securities for a higher return where the default risk is more. With multiple defaults in the market, the debt market has been walloped. It is better for the investors to stick with funds investing in AAA and similarly rated securities.

Investing in mutual funds isn’t the hardest part. Investing without mistakes and tweaking and rebalancing the portfolio is. Investors need to identify if they are committing the above mistakes and rethink their current investing decisions.

Happy Investing!

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