Finance

Mutual Funds: Common mistakes to avoid before investing

A look at the necessary factors to take care of before you invest. Take your time and pick a path that suits your financial aim and investment capacity

Updated: Feb 15, 2021 06:46:49 PM UTC

Rishabh Parakh is a Chartered Accountant by Profession and a founder and Chief Gardener of Money Plant Consultancy, an established firm based out of Maharashtra with operations expanded to Singapore & the UK. He is also an author of the Book titled "Financial Spirituality".

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Credit: Photo Illustration by Avishek Das/SOPA Images/LightRocket via Getty Images

We are in the age of information now. The problem is no longer investors being unaware of the importance of investing or the advantages of products like mutual funds. The problem now is common mistakes that investors make that slim their returns. Again this is not a problem of lack knowledge.

Based on my experience working with many clients over the years, I have identified some common mistakes that people make while investing—particularly with respect to mutual fund schemes. Some of these mistakes are made before investing, and some while or after investing. In this column, let us see some mistakes made before investing:

Not defining financial goals and a timeframe to achieve them Most investors are aware of the importance of diversification and regular saving. What they miss out on, and it may seem ironical, is the absence of a link between their financial goals and investments. It is essential to define your financial goals clearly. For example, funding your children’s education or planning for your retirement and linking your investments to them. This process will help give a clear direction to your investments and help you understand the kind of risk you can take.

Not defining the amount of money required to meet financial goals
Some investors have an idea of the financial goals they need to achieve and the timeframe in which they want to achieve them. However, these investors do not define the amount they need to achieve those goals. Let us consider some examples. If you know that you want to retire at the age of 50, or need money for your children’s education 15 years down the line, you need to estimate the amount you would need. Factor in inflation, and then calculate the amount you would need to invest per month based on the products you plan to include in your asset allocation. Regularly monitoring your investments goes a long way towards helping you achieve your goals in this way.

The expectation of unrealistic returns
Be aware of the returns you can expect from mutual funds as compared to the stock market. You need to invest in schemes that provide returns facilitating your financial goals within the timeframe you want. Take a holistic view of the market along with long-term trends rather than short-term price fluctuations in particular asset classes before investing. This will help to avoid shocks later on. Fixed deposit returns were between 8-10 percent until very recently. They are now at 5 percent and may decrease even further. The real estate market is going through a dull phase right now. While gold is giving good returns now, it was not so much in the last few years. Expectations of up to 20-25 percent from mutual funds are not realistic right now, while they may have been in the past. Look at the long-term trends and the history of the Sensex over the last 40 years. Currently, you can reasonably expect between 10-15 percent returns, provided you stay invested for the long term. At any cost, you should, however, not compare the returns from mutual funds with stocks. Stock market investment needs time, money, and expertise. Plus, it is highly risky.

Not choosing schemes aligned to financial goals
We have already discussed the value of proper diversification and an appropriate number of schemes to invest in. However, it so happens that investors get influenced by maybe advertisements, friends, or family and choose schemes on the basis of someone else’s portfolio. What is right for someone else might be wrong for you. Unless the income levels, financial goals, risk profile, and net worth of this other person are the same as you, you cannot copy their portfolio blindly. Many people are asking whether they should invest in gold or pharma funds right now. They have been giving good returns this year, but it was not so over the last five years. You need to look at your risk profile and financial goals before choosing schemes. Your schemes should always be aligned to your financial goals, and not someone else’s portfolio. Everyone’s financial journey is different.

Lack of research
There are hundreds of schemes available in the market. Before investing, it is always a good idea to get a clear overview of your assets and financial goals before you can build an effective roadmap. This includes preparing your own risk profile, which depends on your goals as well as your thought process about investing. A risk-averse investor may choose to invest a lesser proportion in equity, while someone who does not want to take as many risks will opt for something else. If you wish to invest for 7-10 years or longer, then equity is a great choice for you.

All these choices can be made once you sit down and review your goals and finances. It is equally important to do research about the market. For example, it may not be a good idea to go by the ranking of a mutual fund scheme before deciding to invest in it. Investment is for the future, while the rating is based on past performance. It is important to know their expense ratio, asset size, the company and the fund manager, as well as their past performance. If you can do it on your own, by all means, do it. If not, you can take help from a financial advisor.

Thinking in isolation
Make sure to pick the right schemes that suit your risk profile as well as your goals and investment patterns. Do not focus on the investment cost only. Go for a direct plan, but only if you can take care of all the factors discussed above, and can take timely calls and regularly monitor your investments. Otherwise, enlist the help of a financial advisor who can help take that burden off your shoulders and enable you to focus on your job or business. You are your own stock and the returns you get from your career cannot be replicated through investments. If you feel the need for an advisor, go for it. An advisor can give you the edge in terms of selecting schemes suitable for you.

These are necessary factors to take care of before you invest. Once you have checked all these boxes, you can be sure of being in a good place to start investing. In the next column, we will talk about what you need to take care of once you have started investing.

The writer is a chartered accountant and founder and chief gardener of Money Plant Consultancy

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