Dark Side of Mutual Funds
For growing wealth easily, the most budget-friendly option we assume is Mutual Funds. Ignoring the other side of the coin, people only tend to see the professional management and diversification it offers. Most of the investors, whether newcomers or experienced, fall in this trap that eats their returns.
Take a sigh of relief, the good news is, that you can avoid these mistakes.
How?
This blog will walk you through some of the most common drawbacks of mutual funds investing, including ignoring fees, chasing past performance, etc. You will also get a sneak peek of how to safeguard your money by making better investment decisions.
1: Chasing Past Performance
The most common and biggest blunders usually that every investor makes are investing in mutual funds based on their past results. Assuming that investing in last year’s high return funds will be fruitful and will continue to perform well. But we should not forget that past success does not guarantee future returns.
Why is this a problem?
Fluctuating market conditions affect fund performance from one cycle to another.
Moving forward, high-performing funds may lead to lower returns.
Instead of chasing past performance, focus on investment philosophy, and how it aligns with your financial goals.
How to avoid this mistake:
- Pay close attention to funds’ previous 5-10 years performance instead of focusing on short-term returns.
- Conduct a detailed research on funds performance under various market conditions.
- Focus on consistency rather than flashy one-year gains.
2: Ignoring Fees and Expenses
“Nothing comes for free”, this saying appropriately goes with mutual funds. Mutual funds aren’t free. Every fund comes with costs, including expense ratios, management fees, and exit loads. Most of the investors overlook these fees, assuming them as irrelevant. However, these fees feed themselves through your returns over time.
What to watch out for:
Expense Ratio: For managing your funds, the percentage of your investment used falls under this category. High expense ratio decreases your profit.
Exit Load: If you desire to withdraw your money before its maturity, do watch out for charges imposed for exiting before investing.
Hidden Charges: Read the fine print and ensure you are aware of all possible costs associated with the fund.
How to avoid this mistake:
- Do compare expense ratios before investing in a fund. A lower expense ratio means more of your money stays invested.
- Carefully examining exit loads as it might cost your profit.
- Consider direct mutual funds in comparison with regular ones, as they have lower costs since they don’t involve intermediaries.
3: Overlooking the Fund’s Objective
Before investing, do investigate the fund’s nature and objectives. As each fund has an objective, some focus on growth, while others prioritize quick income. Most investors make this mistake of investing in funds that don’t suit their financial goals. As a result, they might not get the results they expect.
Problems you might face:
For your retirement savings, investing in a high-risk small-cap fund will be unstable due to market ups and downs.
Avoid investing in a growth-focused equity fund, if you want regular income, you may not receive the dividends you need.
How to avoid this mistake:
- Measure the level of risks you can bear with the fund’s risk level.
- Conduct a detailed research about the fund’s investment objective before investing.
- If your goal is wealth accumulation, equity funds might be better.
- If you need stable income, debt funds may be more suitable.
4: Over-Diversification
While counting the advantages of mutual funds, diversification is one of the major ones you can count on. Though it spreads investment across multiple assets and helps in decreasing risk, too much diversification can be injurious for your investment.
How over-diversification hurts your portfolio:
In desire of gaining maximum profit, investing in various funds can lead to average returns.
Tracking the performance of various funds becomes difficult.
Investing in too many funds will reduce the diversification benefits. As there are chances you’ll end up holding the same stocks through different funds.
How to avoid this mistake:
- Stick to 3-5 well-selected mutual funds that offer exposure to different asset classes.
- Check your portfolio for overlap, if multiple funds invest in the same stocks, you’re not truly diversified.
- Don’t invest in funds just for the sake of it,each one should serve a clear purpose in your strategy.
5: Ignoring Market Cycles
Greed and fear can lead to poor investment decisions. Usually it is seen that investors make panic decisions as per highs and lows of the market. Some start selling their mutual funds out of fear as the market drops, while some start purchasing as the market blooms, at high prices. This rush will lead your mutual funds to a pit of losses.
The right approach you should take:
- Avoid getting distracted by short-term fluctuations of the market, consistency is the key,
- Focus on long term investment, and wisely invest through SIPs (Systematic Investment Plans)
- Calm yourself during market downfall, as these are temporary and rushing to sell mutual funds will fetch you losses.
- A well-researched and planned approach will help you sustain the market cycle.
Guidelines to consider before investing in a Mutual Fund
Follow these steps before making any investment decision to safeguard your mutual funds:
1. Study the track record of the fund
Analyze the last 5 to 10 years performance of the mutual fund you are investing in.
Research about its performance under various market conditions/cycles.
2. Watch out for Fund Manager’s experience
Mutual fund performance greatly depends on the skills of the fund manager. So wisely hire one.
Inquiry about their tenure with mutual funds dealing, investing philosophy, and past track record.
3. Compare Expense Ratios
Avoid investing in mutual funds that require high management fees.
Opt for funds with competitive fees, as it will not eat your returns.
4. Assess the Fund’s Portfolio
Do a detailed research regarding the stocks and sectors your funds are invested in.
Choose a balanced mix of assets so that the risk ratio is under your budget control.
5. Understand Tax Implications
Understand and consider the taxation of mutual funds before investing. Different funds are taxed differently. Whether it’s Equity mutual funds or debt funds, both have individual taxation.
Also, check – Herd Mentality in Mutual Fund Management
Wrapping Up
Though one of the best tools for investment is mutual funds, it doesn’t mean you can blindly rely on it, that is free from risks. Taking impulsive decisions during market fluctuations while ignoring the red flags like fees, past performance, and over-diversifying their portfolios, can lead to bad decisions.
For a successful mutual funds investment, focus on key essentials including detailed research, disciplined research, and long-term planning. For maximum return and minimum risks, try avoiding these common pitfalls.
Please share your thoughts on this post by leaving a reply in the comments section. Contact us via phone, WhatsApp, or email to learn more about mutual funds, or visit our website. Alternatively, you can download the Prodigy Pro app to start investing today!
Why is past performance not a guarantee of future returns?
As market conditions fluctuate, predicting that a fund performed well last year will continue to do so in the future is a wrong analysis. Instead of relying on short-term gains, look at long-term consistency.
How do mutual fund fees affect my returns?
Fees like expense ratios, exit loads, and hidden charges reduce your profits over time. Choosing low-cost funds and understanding all charges before investing can help you keep more of your money.
Can investing in too many funds be a bad thing?
Anything over the board fetches risks and losses. As diversification decreases risk but overdoing it can lead to average or poor returns. While making it tough for you to track your investment performance. Sticking to 3-5 well-chosen funds is usually advisable.
How should I handle market ups and downs in mutual fund investing?
Avoid panic-selling when markets drop and don’t rush to invest when prices are high. Stay focused on long-term goals, invest consistently through SIPs, and trust in a well-planned strategy.
Disclaimer – This article is for educational purposes only and does not intend to substitute expert guidance. Mutual fund investments are subject to market risks. Please read the scheme-related document carefully before making an investment.
Invest wisely, stay informed, and build a portfolio that truly aligns with your financial goals.
