Mistakes in investing are inevitable. Many successful investors tend to realise their mistakes early on and take corrective action. Unfortunately, some get carried away with the flow of the market.

This tends to happen especially in times of euphoria, when investors get blinded by the supernormal market returns. Investors tend to overlook the underlying risk. Thus, end up making critical investment mistakes.

As retail investors go gung-ho over equity mutual funds, the market continues to scale to new highs. Consequently, high returns attract new investors and creates a vicious cycle till someone puts a spoke in the wheel.

So far so good, the S&P BSE Sensex breached the 36,000 mark with a return of 30% over the past year. Assets Under Management (AUM) of the mutual fund industry jumped over 32%. This is thanks to the increase in participation of investors from the smaller towns.

Between December 2016 and December 2017, the asset base of the smaller towns had soared 47%, from Rs 2.85 lakh crore to Rs 4.20 lakh crore. Investors in the smaller town were betting big on the equity markets. Equity AUM of B15—cities Beyond Top 15, formed 60% of their total AUM.

The number of mutual fund folios grew by a staggering 1.37 crore in 2017 to an all-time high of 6.65 crore. Equity mutual fund folios stood at a record high of 4.93 crore.

There is no doubt that equity has become increasingly attractive.

At such times, investors tend to make critical investment mistakes — by either being overoptimistic or being overcautious.

What are these mistakes, and how to correct them? PersonalFN explains below.

Mistake #1: Expecting supernormal returns over the short-term

Yes, the markets have generated astounding returns over the past year. Investors have flocked to the market seeing the double-digit returns over the short-term. However, what you need to realise is that market returns fluctuate. Just because the Sensex generated a return of 25%+ in 2017, do not take for granted that the index will once again deliver the same kind of returns in 2018. The index may even generate a negative return as seen in 2015.

What you should do: When investing in equity mutual funds, you should always maintain an investment horizon of five years or more. The volatility of the market is unavoidable and unpredictable. But, over the long term, the market is expected to move higher. Hence, the best way to tide over the market volatility is to invest for the long haul.

Mistake #2: Increasing exposure to mid- and small-cap schemes

Mid-cap and small-cap funds have generated a return in excess of 40% over the past year. Certain small-cap oriented scheme have delivered a return in excess of 50% in the past 12 months. The enormous returns are certainly attractive. Many would now be contemplating on increasing their exposure to such funds due to their massive return potential. While investors would have certainly benefitted with midcap funds in their portfolio, increasing exposure to them now would be an imprudent strategy.

The S&P BSE MidCap Index and the S&P BSE SmallCap index are commanding a price-to-earnings (P/E) of over 45x and 110x each. The valuations seem highly unsustainable and pose a greater downside risk.

What you should do: With valuations stretched, it would be best to maintain a limited exposure to mid-cap funds. This does not mean to exclude them from your portfolio altogether. If you have set an asset allocation for your financial goals, stick to it.

Mistake #3: Picking equity funds based on their short-term performance

A rising tide lifts all boats. Similarly, in a rising market, all equity funds tend to perform well. The list may include some surprising outperformers as well. Schemes that may have not performed very well in the past may feature in the list with exemplary returns. Over the past year, schemes that have been infamous for their underperformance feature among the top schemes. However, if you pick schemes solely based on their short-term performance, you may be in for a disappointment.

What you should do: When picking winning equity funds, you need to focus on consistent performance over the long term. The scheme should have been able to perform across market cycles. A scheme that has done well recently, but failed to generate impactful returns in the past is best avoided. Similarly, schemes that have performed consistently with superior risk adjusted returns should be your focus.

For additional reading:

Mutual Funds With Multiple Star Ratings! Whom Should You Trust?

Sensex Soars Past 30,000—Are you Investing In The Right Mutual Funds?

Should You Worry About The Performance of These Large Sized Funds

Mistake #4: Investing without a plan

This is one of the biggest mistakes one could make. Investing in an ad hoc manner could lead to inefficient savings and inadequate returns. Getting carried away by the success stories of others and investing in mutual funds without considering your financial goals, risk appetite, and most importantly, current financial situation, will prove to be a mistake in the future. Investing without planning is like driving without directions.

What you should do: Before you invest, it’s always better to take stock of your needs. A personalised financial plan is a must. It gives you a clear-cut roadmap for your financial journey. It offers you various routes to reach your destination. Some routes might be short, but full of pitfalls; while others might be longer, but relatively safe. A sound financial plan considers your financial objectives, current stage of life cycle, available financial resources, and the time horizon of your financial goals . Based on this, it gives you guidelines to make your dreams come true

Mistake #5: Stopping regular investments

Given the high market valuations, a certain set of investors may grow overcautious. In such situations, they may want to stop their ongoing investments in equity to protect their portfolio from a probable downside. However, when the markets will correct, no one knows. Hence, this shot at market timing may lead them to miss out on additional returns.

In the past, when the market went through a rough phase, small investors refrained from investing in mutual funds as well as signing up for Systematic Investment Plan (SIP) in equity mutual funds. Many even cancelled their SIP investments. This was a grave investment mistake.

What you should do: We acknowledge the fact that the Indian equity market is at its peak, and one should buy low and sell high, a basic tenet of investing. However, stopping your investments waiting on the sidelines for the market to correct will be an imprudent strategy.

When the Sensex breached the 30,000 mark in April 2017, the all-time high then, those who were expecting a correction would have been disappointed. As we know it, the Sensex has gone on to hit the 36,000 mark with impunity. Investors who did not jump in then, would have lost out on returns as much as 20%.

Mistake #6: Switching from equity to debt or hybrid funds

Some investors may even consider shifting out of equity mutual funds to low-risk debt funds or even hybrid funds liked balanced funds or Monthly Income Plans (MIPs). While there are pros and cons of such a strategy, investors should refrain from taking an uncalculated decision. While it is essential to rebalance your portfolio from time to time, blindly switching your investment from equity to debt can create an imbalance in your portfolio.

If you have set out to reach your financial goals, you would have set a specific asset allocation. Along with the market swings, realigning your portfolio does make financial sense. However, switching out your entire portfolio or moving out of equity without a plan can dent your overall returns. One needs to pay heed to the tax aspects and exit loads as well.

What you should do: Strategically rebalancing a portfolio is correcting the deviations in the original asset allocation. For example, you invested 70% in equity, 20% in debt, and 10% in gold—after a year, equity accounts for 80% of the portfolio, and gold contributes 12%. You will then need to reduce the exposure to equity and gold by shifting to debt in order to achieve the initial asset mix. Rebalancing your portfolio in this way helps safeguard investments from a bad market phase not only by booking gains, but also by reducing the exposure to risky assets.

For additional reading:

5 Ways A Mutual Fund Portfolio Review Can Boost Long Term Wealth

Top 5 Reasons To Sell Your Mutual Fund Schemes

Why You Should Strategically Structure Your Portfolio Now?

Mistake #7: Selling good funds due to short-term underperformance

You need to realise that mutual funds are not always perfect. If you have spent over a decade analysing mutual funds as PersonalFN has, it is common to see certain mutual fund schemes rise and fall. There may be no doubt that star performers may have done exceptionally well in the past. Unfortunately, some star performers often fail to keep up their consistent performance of the past.

High quality funds may falter if the fund manager’s bets do not play out as expected, or if the fund is flooded with investments, leading it to change its investment strategy. Though such funds may still outscore their benchmarks, they tend to lag behind their peers. But, should you prune out such funds from your portfolio?

What you should do: It is necessary to analyse funds on both quantitative and qualitative parameters. While the quantitative factors delve in to the fund’s past performance, the qualitative aspects rate the fund manager’s experience, investment systems and processes, among other things. The funds need to be picked through rigorous selection processes, keeping in mind your risk profile, investment objectives, and financials goals.

Thus, a fund which has done extremely well in the past, but lags in the short-term should not be culled out immediately. You may need to watch the performance of the fund closely. If over a period of 6-12 months, the performance does not improve, avail the services of a professional, such as an investment adviser, who will guide you to take the right decision.

The buying and selling of mutual fund schemes should be carefully tuned to your financial needs.

To conclude

“It’s very difficult in the investment business to avoid mistakes. You are going to make mistakes.  The key is to keep learning” - Mohnish Pabrai, Managing Partner of Pabrai Funds, CEO of Dhandho Funds

Avoiding these seven mistakes will take you a step closer to becoming a successful investor. These are just a few common mistakes made by the average investor. In your investment journey, you may encounter several hurdles and may even make many mistakes. It is important to learn from these mistakes and take prompt corrective action where possible.

Remember, investing in equity requires discipline, patience, and perseverance. If you are looking to make quick returns, then sadly you could end up burning a hole in your pocket.

MustRead

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madhupur.suraj@gmail.com Jul 28, 2018 Want to invest rs.20000 per month in SIP. Pls.help in selecting the best portfolios.

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