Common Mistakes Investors Make when Investing in Mutual Funds or Unit Trusts (and How to Avoid Them)
Mutual funds are popular investment outlets for people with not so huge investment budgets. One reason investors prefer to invest in mutual funds or unit trusts is that the funds are professionally managed. At least that is the impression.
Mutual fund managers are known to be hands-on in taking care of their client’s investments. They provide a comfort level to investors by way of efficient asset allocation and fund identification. It also offers diversification to mitigate risks and preserve capital.
Still, even with the excellent product characteristics, there are common mistakes committed by investors. You should take note of these mistakes and avoid them when investing in mutual funds.
1. Fund selection is not consistent with financial goals
Prior to investing in mutual funds, it would be helpful to have a well-defined financial goal. The nature of a mutual fund is basically for a long-term investment.
However, the recurring mistake of investors is investing in an equity-based fund although the investment time frame is long-term. Thus, the mutual fund chosen is not aligned with the financial goal.
In some cases, investors commit the mistake of investing in long-term debt fund when the invested capital will be retrieved in a month’s time. In both scenarios, investors think they’re seizing the opportunity.
Returns can’t be maximized when there’s a mismatch in the type of mutual fund and the financial goal.
2. Basing a decision on previous performance
A fund’s performance is not predictable. Even if a fund performed creditably in the past doesn’t mean it will continue its streak in the present. While the past performance can assist the investor clear the list of non-performing funds, it shouldn’t be the sole basis for choosing a particular mutual fund.
“Chasing returns is a very common mistake made by investors,” said TJ Tan, CFA, DCG Capital. DCG Capital manages the Asia Value Fund, which invests in publicly listed companies in Asia, ex-Japan, based on a value investing approach. Find out more about the fund here. “Funds exhibit mean reversion, or a tendency to move back to its mean price, so the outperforming fund for this latest X or Y period is unlikely to be the fund to outperform in a later period.”
Mutual fund investors have the penchant for chasing after short-term or previous handsome returns. The sooner they realize the past does not guarantee desired returns, the better. Proper evaluation should take precedence over the past. For, after all, the winner of the recent past may be a losing proposition this time around.
3. Falling prey to higher returns
It is easy for mutual fund investors to be tempted by higher returns. Objectivity is lost and there’s a total disregard for risk profiles. Investors should keep in mind the amount of risk attached to a particular investment.
The norms should be emphasized. You don’t expect companies with good credit ratings to offer higher interest rates. Because the investment is low-risk, it follows that the return is lower too.
If you want higher interest earnings, you can handpick companies that have low credit ratings. If you want to derive sustained, regular income from your mutual fund investment, avoid the charm of higher returns.
4. Concentration on a specific sector
The age-old investment adage “don’t put your eggs in one basket” applies even in mutual fund investing. Some investors fall into the habit of concentrating on a specific sector or industry portfolio.
That is a major blunder you need to avoid. For example, health funds might be offering fantastic returns at the moment. But the moment there’s an unexpected market reversal, you’re in grave danger of losing your hard-earned capital. The lesson here is to invest in funds with diversified opportunities.
5. Too many mutual funds
Some investors bet on 10 or more mutual funds all at once. While diversification is a salient feature of the product, investing in too many will be difficult to manage. Besides, it will no longer add value to your portfolio but instead, diminish your returns in the long-term.
Preferably, it would be safer to limit your investment to not more than 5 at a time. That would be easier to handle and less cumbersome when you do a periodic semi-annual review. Also, that would be sufficient to cover a wider investment spectrum if that is your objective.
6. Dividends focused
Long-term investors are easily lured by the dividend option in a mutual fund. It’s the laid-back attitude of some but it’s a common mistake as in mutual fund investing.
Don’t be sweet-talked by mutual fund salespersons. When there’s a promise of sustained, unimpeded dividend payouts to boost your earnings, more often than not, it’s untrue.
7. Missing out on proper asset allocation
When you’re investing in mutual funds, do not disregard the importance of asset allocation. Some investors tend to lose focus on this vital element. There is the need to always bear valuations in mind.
The purpose is to have an acceptable proportion of investment in different asset types (equities, commodities, real estate, etc…). If there’s no proper allocation, you place your financial resources at risk.
Another mistake is keeping an overvalued asset. The remedy is to dispose of the asset and replace with a fairly undervalued asset.
The three important stages of investing are planning, execution and then reviewing the investment periodically. And these hold true for mutual funds as well.
8. External influence
An intelligent investor will not be influenced by the success of others. Some base their decisions on the strategies proposed by outside parties. You can take hints and tips but you’re solely responsible for your money.
Tan calls these investing in “short term thematics”, where investors invest in funds or structures simply because they are the “flavor-of-the-month or year”.
Do your own due diligence and review the fine prints of any mutual fund investment proposal. By allowing yourself to be influenced by outside parties is like investing blindly or carelessly.
The minute you personally take charge of your investments, you serve your own interest.
9. Not knowing their fund managers
Some investors choose to invest in certain mutual funds because of the fund house. But a reputable fund house does not necessarily make a fund better.
“Many investors associate brand names with funds,” says Tan. “Fund management, like elite football, is a talent driven service. Regardless of the brand name attached to a football club, if the key talent has left, the team will not be able to play as well. The same applies to the key fund manager of a fund. If that key talent leaves, investors have little assurance that the substitutes would be just as competent.”
“So, investors need to figure out who’s playing on their team,” Tan concludes.
Now that you know the common mistakes committed by investors when investing in mutual funds, be extra careful. Perhaps you’ll commit one or two as a beginner. However, committing the same mistake can disrupt your financial goals.
What this article is trying to impart is that risks are always present in any investment endeavor. Mutual funds are not exempt. It is your duty to follow the basic stages of investing and take no shortcuts.
Investing in mutual funds requires careful planning, precise execution, and periodic review of investments. The fewer are your mistakes, the better.
ZUU Investment Disclaimer: The information given above is based on our experts’ field of expertise and their own personal experience, and should not be relied on or construed as financial advice. ZUU online recommends that our readers take these pieces of advice as a starting point, to research and then assess the merits of this advice based on their own financial needs, investment goals, and risk tolerance.