Falling yields on bank fixed deposits, bonds and declining returns on real estate and other asset classes have led to a significant increase in retail investors’ participation in mutual funds. However, lack of awareness about mutual funds and capital markets often makes many retail investors commit investing mistakes.
Let’s look at some of the common mutual fund mistakes and how to avoid them:
Comparing NAVs to select mutual funds
A common misconception among retail investors is that mutual funds with lower NAVs are cheaper. This misbelief promotes New Fund Offers (NFOs), given that their units are issued at face value of Rs 10. However, the NAV of a fund can be low or high due to various reasons.
For instance, as the NAV of a fund depends on the market price of their underlying assets, NAV of a well-managed fund can grow better than other funds. Likewise, funds that are relatively newer have lower NAVs than older funds because the former received less time to grow. Thus, one should not factor in NAVs for fund comparison and instead, take into account the fund’s past performance and the future prospects of outperforming their benchmark indices and peer funds.
Investing for dividends
Many investors assume mutual fund dividends to be some kind of windfall income, which makes them opt for the dividend option of mutual funds. However, what such investors fail to understand is that the declared dividends are paid from their fund’s own AUM. As a result, the NAV of a dividend declaring fund gets reduced by the amount of dividend paid.
Moreover, the dividend amount gets calculated on the basis of the fund’s face value and not on their NAVs. For example, suppose a fund with an NAV of Rs 70 declares a dividend of 30 percent, the dividend amount will be Rs 3 or 30 percent of fund’s face value, which is Rs 10. Thus, the NAV will fall to Rs 67 after the dividend record date.
Also, note that the dividend option is less tax efficient as compared to the growth option for the ones falling in higher tax slabs because the dividends earned by the MF investors get taxed on the basis of their income slabs.
Thus, those seeking to generate regular income from their MF investments can choose a dividend option. Those looking to benefit from the power of compounding over the period of time should choose growth option instead of dividend option.
Stopping SIPs during bearish market condition
Volatility is an inherent feature of equities. However, steep market corrections or bearish market conditions lead many investors to stop their SIPs fearing further losses. But, doing so may be detrimental for equity investors as steep corrections or bearish market conditions provide excellent opportunity for purchasing higher number units at lower NAVs and thereby, average the investment cost and generate higher returns over the long term.
Instead, investors with investible surplus should further exploit market corrections and bearish market conditions by topping up their SIPs through lump sum investment in a staggered manner on the basis of their asset allocation strategy.
Doing so will allow the investors to further average the investment cost and help them in reaching their financial goals sooner.
Overlooking investment objective/strategies of mutual funds
Mutual funds state their investment strategies, objectives, asset allocation strategy, etc in their communication documents like product leaflets, emailers, SID (Scheme Information Document), fact sheet, product presentations. These documents help investors review and understand whether a fund would suit their financial goals and risk appetite. However, many mutual fund investors overlook such important information and end up opting for funds that do not suit their financial goals and risk appetite.
Expecting unrealistic returns
Exceptional returns generated during bull markets encourage a large section of retail investors to begin their mutual fund journey. As a result, many compromise their liquidity by investing their short-term surpluses in equity mutual funds in the hope of generating exceptional returns. Some also end up investing in equities for achieving their short term financial goals.
However, returns generated in the course of a bull phase cannot sustain over the long run and every bull market is accompanied by a bearish market or correction phase.
When the equity market witnesses bearish market or correction phase, such retail investors either stop investing or redeem their investments in panic at a loss to meet their cash flow needs or short term financial goals.
It is best to have realistic expectations from mutual funds and have a sustainable investing strategy.
Sahil Arora is Director and Group Business Head – Investments and Credit Cards at Paisabazaar.com. Paisabazaar.com is part of PB Fintech that also owns India’s leading insurtech brand, PolicyBazaar.com.
