6 Mistakes to avoid while selecting a Mutual Fund

Vaibhav : Yaar Niraj, you had said that “Mutual Funds Sahi Hai”. But I am incurring losses in my Mutual Fund Investments. How does that happen?

Niraj : That’s surprising. How did you select the mutual funds?

Vaibhav : Very Simple. I went to this popular xyz website and saw the list of highly rated mutual funds and invested in them. Also, some mutual funds were told by my banker as they were available at Rs. 10 NAV. So I invested in them.

Niraj : There you are. I now understand why are you making losses. Your selection process itself is wrong. Let me tell you the 6 mistakes to avoid while selecting a mutual Fund.

Mistake 1 : Looking at Past returns as the only parameter for selection

Most of us just look at the past returns and invest in the fund. This is like driving the car forward by looking at the rear view mirror. We must research and understand the future potential and not chase past performance. Remember, the mutual funds themselves say “Past Performance may not be sustained in future”

 

Mistake 2 : Looking at Star Ratings given by websites.

This mistake is almost similar to 1^st mistake. This is because the ratings are mainly given based on past performance. So if you don’t look at past performance but go by star ratings, it will be like saying, “Doctor has advised me to stay away from Water Melon, that’s why I am having Water Melon juice”

Mistake 3 : Getting Carried Away by Fancy names

Some investors get carried away by Fancy names. When a fund is launched with fancy names and fancy taglines like “Make In India theme” or “Ujjwal Bharat Theme” or likewise, investors think that these funds are going to be the only beneficiaries of the government schemes.

There are some investors who think that if they want to invest for the good future of their children, the fund should have the word “Children” in its name.

This is like saying, for treating malaria , the medicine should have name like “Malaria-Go”;  only then it can cure malaria.

 

 

Mistake 4 : Getting trapped in the Rs. 10 NAV

This happens mostly when there are number of NFOs coming up. All of them offer the units at Rs. 10. As a result, investors think that they are getting it very cheap and they will get more units if they invest in NFO.

This is like saying, when you withdraw money from bank, the banker asks you, should I give you Rs. 100 notes or Rs. 10 notes, and you say, please give me Rs. 10 notes as I will get more notes and I will have more money.

In most general cases, going with an established fund could be a better idea than an NFO. In fact, the NAV has no role to play in wealth creation. If the underlying portfolio grows, the NAV will grow. If a Rs. 10 NAV can become Rs. 20, then a Rs. 100 NAV can become Rs. 200 in the same time frame.

 

Mistake 5 : Selecting the fund looking at the monthly dividend “promise”

There are some funds which are (wrongly) promising an unrealistic and unsustainable monthly dividend of say 1% and investors (including senior citizens) are falling for it.

Lets understand that, an equity oriented mutual fund has a “potential” to generate a return of 12-15% in the long term. But such promises of “monthly dividend” will turn sour, the moment market turns around in the short term. Lets not fall prey to such fooling commitments.

 

Mistake 6 : Not following asset allocation.

There are times when a particular asset class does well and other asset classes do poor or average. Investors get tempted to move “ALL” their money in the performing asset class. Lets remember, if bananas become cheap in a particular year, will we only have only bananas in our meal ? Or will we still continue to have a balanced diet.

Similarly, your fund selection has to be in line with your risk profile, goals and asset allocation. Some people will see that Gold is giving only 5% return and Debt is giving only 8% return whereas small cap has given 20% returns, and they will move all their money to small cap. As a result they run a high risk of incurring losses in the short to medium term.

 

Vaibhav : Wow yaar. I never thought about all this in detail. I thought mutual fund selection is a very simple process.

Niraj : Well, I would say, it is simple for someone who gives lot of time and does the in-depth research. But people who don’t have so much time and expertise, should always go for a professional advisor who can help them. The fees would be far lower than the losses we could incur by making these mistakes.

Vaibhav : Ohh yes , that’s why I keep hearing, “Mutual Funds Sahi Hai, Par Advisor Zaruri Hai”

We look forward to your feedback and comments on the above article.

The Author Prof. Saurabh Bajaj (BE, MBA, FRM, CFGP) is CEO with Nidhi Investments, Mumbai. His articles have a readership from 78 Countries across the Globe. He may be contacted on CEO@nidhiinvestments.com if you have any questions.

(The views mentioned in the article are personal opinion of the author. The characters used in the article are real with names changed).

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