Dos and Don’ts of Investing in Mutual funds

As a retail investor, let me share the dos and don’ts of investing in mutual funds and categorise them for better understanding.

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The benefits of investing in mutual funds are limitless. The best advantage of investing in mutual funds is they allow investing as low as ₹500 per month.

So anyone can build up a corpus with a small amount every month. It can be a good substitute for chit funds as well.

However, there are some dos and don’ts that one should follow when investing in a mutual fund. So let me share them with you.

Fund Performance

New retail investors are obsessed with the past performance of the mutual fund. So let me share some of the key Dos and Don’ts concerning the fund’s past performance.

• Don’t: Invest in a fund without reviewing its past performance.
• Do: Select a fund with a track record to outperform in the market’s bull and the bear phase.
• Don’t: Opt for a fund for its recent or current (in the past year or so) performance.
• Do: Follow the reports released by mutual fund agencies for the funds.
• Don’t: Check NAV Daily. It will not make much of a move just because you keep a keen eye on it.
• Do: Check NAV and performance quarterly or at specific intervals to see if you should continue investing in the fund.

Investing in a mutual fund is all about future performance, not past performance. So have a view about the future sectors and see if the fund is investing in the sectors you are bullish as well.

SIP Vs Lumpsum

A mutual fund allows you to invest a small amount in the market to help you build a corpus for future goals.

So I always recommend investing in mutual funds via SIP. Yes, a knee jerk fall in the market can mean you can make some lump sum investment, but such opportunities are far and few in between.

• Don’t: Invest huge amounts all at once
• Do: Invest via SIPs

Also read:

SIP or Lump Sum – Which Is Better Investment in Mutual Fund For 10 Years?

When I read this question the initial reaction is always SIP but when I compared the returns, I realized that it is not always SIP that is better.

Patience is the Key

If you want to build wealth in the market, you need to have a lot of patience. Patience on both fronts – First, to remain invested in the market and second, to hold the cash levels and deploy them at the right time.

• Don’t: Panic
• Do: Hold your patience.

It is effortless to place a purchase order or sale order in the market. However, real wealth can be built if you are patient enough to avoid it.

Peter Lynch has studied the market more than anyone else, and he has said that the market gives a correction of 10% or more every two years.

You will have ample time in the market to deploy your funds.

Be patient.

Then, you will see those corrections after you have deployed the funds.

So, Be patient.

Comparison

We live in the era of social media, where every achievement is overly exaggerated. So you have to learn not to compare your portfolio’s performance with others.

Investors in India compare that if Warren Buffett had moved his investment from Coca-Cola to Pepsi, he would have made more money.

I don’t want to name them, but I know they aren’t an investor in them, aka Pepsi or coke. So anyone can tell from hindsight, but the critical point is at that time to invest such an amount and then remain invested in it.

• Don’t: Compare your returns with others. The investment should be aligned with your goal and not beat others in the market.
• Do: Focus on absolute returns than outperforming your neighbours.

Just remember, the longer you stay, the more you earn.

Expenses

You shouldn’t compare returns, but there is one thing that you should constantly compare, and it is the expense ratio.

• Don’t: Ignore expenses
• Do: Compare expense ratios

Also read:

Expense Ratio – Answer to Every Investors Every Question on Expense Ratio

Everything An Investor Needs to Know About Expense Ratio Before Investing In any equity Mutual Funds in Indian Markets in an easy Question and Answer Format.

Investment Goal – Risk Vs Return

Once you have a goal for the investment, your focus shifts from returns to risk-adjusted returns.

For example, small-cap funds always perform better in a bull market, but large-cap funds give the stability that your portfolio may need.

So, once you know the CAGR return you want for the investment’s goal, you will focus on the risk more than the return.

• Don’t: Invest without understanding your risk-taking ability.
• Do: Invest with a Goal and minimise the risk.

Also read:

Investment Return Vs Investor Return – Why Investors Earn Below Average Returns?

The average retail investor isn't able to create wealth in the market despite markets doing so well. Why there is so much gap between investment return and investor return?

Direct Funds

Many investors cannot differentiate between a regular and direct plan for investing in a mutual fund.

• Don’t: Invest in Regular Fund
• Do: Invest in Direct Fund

Direct funds help reduce the expense ratio by almost 1%, generating much better returns for the investor. I recommend you check out my article How To Switch From Regular Funds To Direct Plan?

Focus or Diversified

One fund in each category is suitable for diversification. Having three large-cap funds, four mid-cap funds, and two small-cap funds will not provide you with the needed diversification.

• Don’t: Over Diversify
• Do: Focused investing
• Don’t: Opt for more than 4 to 5 funds
• Do: Diversification with Thematic funds
• Don’t: Invest the entire amount in a fund though it is a balanced fund.

Index funds are much better than mutual funds in many ways. However, studies have shown that 80% of the funds cannot beat the indices in the very long run.

Also read:

Index Funds Vs Mutual Funds – Why It Makes Sense To Invest In An Index Fund?

How Index funds differ from the traditional large-cap fund? Why it makes more sense now after the new SEBI guidelines to invest in an index fund over a large-cap fund?

Investment Horizon

Equity mutual funds investments are subject to market risks. However, if your time horizon is less, your risk amplifies.

• Don’t: Invest for under three years.
• Do: Invest at least for a decade.

Invest in the market the money you won’t need soon.

Experts are Everywhere

Everyone is an expert when it comes to recommending mutual funds.

There are various MFs available like small-cap, mid-cap, large-cap, Flexicap and hybrid funds. You will need a certified financial planner to help you recommend them to you.

• Don’t: Ask strangers for investment advice 🙂 including me.
• Do: Your research or opt for a certified planner.
• Don’t: Make decisions based on the advice of a commissioning agent or analysts on the TV channels.
• Do: Take responsibility for your financial decisions.

Learn from everybody but take your decision and own them. You will make wrong decisions, and everyone in the market does it. Learn from them and move on.

Nominee

Finally, we all invest our hard-earned money for our loved ones. And we are investing for the long term.

• Do: Mention your nominee while investing in the market.
• Don’t: Sign any blank documents even if you know the person well

Finally, always keep your KYC updated with current details.