Sharp correction of March 2020 and subsequent quicker recovery has attracted many investors to equity market. Majority of them are investing through mutual funds. I wish to warn these new investors against the mistakes which novice commit while investing in equity mutual schemes. Let us discuss some of the major mistakes.
Making investments without linking it with any financial goal
Your investments should always be linked with some specific financial goals. It can be education and marriage of your children, buying a house, a foreign vacation or even your own retirement. If there is no goal, wealth creation is also a valid goal. The product for investments will differ depending on tenure of the goal, criticality and flexibility of the goal. A foreign trip or house purchase can wait but not the education or marriage of your children. Since one has to move the accumulated corpus in equity to a safer product as the goal nears, this cannot be done unless the investments and goals are linked.
Expecting unrealistic returns
Recent rally has made people to believe that equity can always give superlative returns and have set their return targets very high. You should be realistic on returns which your mutual fund investment would generate. In my opinion, your equity mutual funds should give you around inflation + 6% return in the long run and one should be happy with that.
Expecting consistent returns in short term
Equity investment gets you higher returns in the longer run but in the short term it may even land you in losses. So to expect consistent returns like a fixed deposit from equity investing is the mistake lots of novice investors commit. One should be aware of the fact that the returns here are not consistent and are volatile so the product is risky for short tenure.
Treating dividend option as regular income
Any dividend paid to you in any mutual fund scheme is effectively paid out of NAV (Net Asset value) of your fund and thus effectively goes out of your pocket. The NAV of your scheme comes down, after the dividend, to that extent. Moreover, the dividends are taxed at your slab rates but if you opt for growth option while investing in mutual funds, the short term profits are taxed at 15% and long term gains enjoy full exemption up to ₹1 lakh and the balance is also taxed at concessional rate of 10%. So for those in higher tax slabs it makes sense not to opt for dividend option. However, there may be situations where opting for dividend option may be beneficial. Please get it evaluated by your tax advisor in advance.
Non-diversification or over-diversification in fund houses and schemes One should not put all his eggs in one basket. This philosophy should be implemented by asset allocation while investing. While making investments one should diversify across asset classes, like equity, debt and gold. Moreover, the assets have also to be periodically rebalanced. If you follow the principle of asset allocation and do rebalancing periodically, you will certainly be able to maximise your returns. So in case one does not follow the asset allocation even one major correction in the asset class may result into wiping out the profits and may result into losses as well as difference asset classes do not always move in the same direction.
Even while investing in mutual fund you should diversify your investments across mutual funds and across various categories of funds. Ideally you should have not more than five equity schemes in the portfolio. You should also not invest in any and every scheme which is doing good. You can gulp while of the sea.
Not taking stock of performance of the investments periodically
Reviewing your investments periodically is the most important part of the investment journey. Even when you link your investments with specific goal, you still need to check on performance of your investments to see whether it is progressing at the projected pace else you may have to either increase the investments amount or moderate your goals. Please note over-reviewing is also injurious. You should not look at the performance of your equity schemes every month and take the corrective steps. Ideally you should review it once in a year.
Investing in mutual funds based on NAV(Net Asset Value)
Novice investors evaluate the equity schemes on their basis of their NAV and schemes with lower NAV look cheaper to them and that is the reason many investors rush to subscribe to NFO (New Fund Offer) at NAV of ₹10.
Attempting to time the market
Novice investors generally get panicky when market corrects and withdraw their investments and stop their ongoing investments through systematic investment plans (SIP) fearing further fall. As the saying goes, you should be greedy when everyone else is fearing and should fear when everyone else is greedy. Correction is the right time to invest more rather than withdraw your investments.
Balwant Jain is a tax and investment expert and can be reached on firstname.lastname@example.org and @jainbalwant on Twitter.
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