When you are new to investing, it can seem a little overwhelming to pick the right mutual fund to suit your financial goals. First-time investors are taken in by factors that may have no bearing on the performance or value of the fund. We provide you a list of six don’ts when you invest in mutual funds.
1. Don’t look at NAVs like stock prices
New investors tend to get carried away by the proposition that a mutual fund which has a low net asset value (NAV) must be cheap to buy.
The NAV of a fund is calculated as the total value of its holdings minus liabilities divided by the number of units held by investors. A mutual fund’s NAV is not like the price of a share, which is determined by market forces such as demand and supply and reflects the market’s opinion of the stock.
Imagine two mutual funds (A & B) with the identical portfolio and liabilities. Both have a corpus of Rs 10,000. ‘A’ has issued 100 units to the public, ‘B’ has issued 1000 units. The NAV of A is 100, the NAV of B is 10. Since both funds are identical and will give identical returns, the NAV is misleading.
Instead of looking at NAV, investors must compare funds by factors such as expense ratio, portfolio, pedigree of fund manager and mutual fund house, ability to meet your financial goals, returns, risk, etc.
2. Don’t buy a New Fund Offer for its NAV
New Fund Offers or NFOs of mutual funds are usually priced at Rs 10. Investors are tempted by the low price. But, as explained in point 1, the price of a mutual fund is not a true reflection of its value as an investment. New funds usually have higher expenses than established funds and do not have a track record for you to evaluate.
Invest in new funds if they offer you something unique or innovative – a new sector, a new index or a new style of investing that is in line with your goals.
3. Don’tmerely go by past performance
Even though all mutual funds put up this disclaimer, new investors tend to ignore this advice. Looking at a mutual fund’s performance in isolation can be misleading. In a rising market, a mutual fund may have given exceptional returns, but it may still have underperformed its category.
Compare performance of a mutual fund against similar funds. Look at its performance in different market conditions.
4. Don’t use Mutual Funds for speculation or trading
Many investors use MFs to speculate or try to time the markets. They buy when markets are rising and try to sell when the markets fall. This is not a healthy way of investing in mutual funds. The best strategy is to invest regularly through systematic investment plans or SIPs. If you do this, you don’t the need to time the market,and you can ride out volatility with less risk.
5. Don’t skip the details
At the end of the day, there is no way around doing some deep diving yourself about the funds you invest in. Sit with your financial planner and press for information on the following parameters of the mutual funds or look it up yourself.
Quality and weight of stocks in the fund
Fund’s turnover rate
Risk and return
Fund manager’s background, expertise and track record
Credit quality in case of debt funds
6. Don’t be without a plan
This is true for all investments and not just mutual funds. You must have a financial plan that considers your short-term, medium-term and long-term financial goals. And your mutual fund investments must help you achieve them. If you are new to investing, consult a financial advisor to create a plan for yourself.