Mistakes by first-time mutual fund investors

We all make mistakes and they are part of our learning curve. This rule applies to new mutual fund investors as well. However, there is also a saying that wise people learn from their own mistakes, while wiser ones learn from others’. If you are new to the world of mutual fund investments, you can benefit by apprising yourself of the most common mistakes committed by new investors.

1. Equating low NAV with cheap NAV:
   Many MF advisors and distributors use the myth of ‘low NAV’ to sell new fund offers (NFOs). Many investors believe that funds having low NAV are cheap as they equate NAV of mutual funds with the market price of shares. However, this is untrue. While the market price of a share is determined by stock trading in a stock exchange, NAV of a mutual fund is calculated by dividing the net value of the fund’s assets
    by the number of its outstanding units. Let’s say, you have two mutual funds A and B with identical portfolios and same amount of assets under management (AUMs) of Rs.1000 crore. Now, assume that A has 20 crore units while B has 10 crore units. In this case, A’s NAV will be Rs 50 (i.e., 1,000/20 = 50) while B’s NAV will be Rs 100. Now, assuming that A is cheaper than B is wrong. In this case, the lower NAV of B is because B has lesser number of units and not due to its performance. Therefore, NAV should not be a yardstick to compare mutual funds.
2. Buying MF to earn dividend: Many MF distributors advise their clients to invest in a mutual fund that has just declared dividend, and thus earn free dividend. However, what they do not disclose is that the dividend is paid out of your pocket only. As soon the dividend is paid out, the NAV of the fund is reduced by the amount of the dividend paid. Let’s assume that the NAV of a mutual fund is Rs 53 and a 20 per cent dividend has been declared (which means 20 per cent of face value Rs 10, i.e., Rs 2). As soon as the Rs.2 dividend is paid out, the NAV will come down to Rs 51. Therefore, investing in fund to just earn those dividends is a futile exercise.
3. Investing without understanding the investment objective of the fund: Every mutual fund has an investment objective, which will give you a broad idea about the working of the fund. You can find out the investment objective in Key Investment Memorandum (KIM), Scheme Information Document (SID) and other product details. The investment objective will state the theme of the fund, asset allocation to be followed, and the type of securities the fund will invest in.
4. Over-expectation from mutual funds: Most of the first-time investors have unrealistic expectations from equity mutual funds, especially during bull markets. Many of them go to the extent of expecting up to 30 per cent annualized returns from mutual funds, which is generally not sustainable in the longer run. Ideally, you should expect 12 per cent–18 per cent annualized returns from your mutual fund investments. Unsustainable expectations may prompt you to exit reasonably good fund for a weaker one. For optimum returns from equity funds, you should try to stay invested for at least 5 years.
5. Not diversifying enough: Many first-time investors commit the mistake of investing their entire investible surplus in just one fund. Instead of putting all eggs in one basket, diversify by investing in different fund themes (such as large-cap, mid-cap, small-cap, debt or balanced fund). This way, even if a particular fund under-performs its peer funds or benchmark index, your investments in other funds may provide superior returns and balance out overall returns from your portfolio. Similarly, you can also reduce your risk by investing across different fund houses, which will ensure multiple fund management styles in your portfolio.

(The author of the article is the Managing Director of Paisabazaar.com)

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