August 23 , 2012
Investing in mutual funds is a good habit. The best benefit of mutual funds is that they allow diversification of investment at a lesser cost than could be possible for you as an individual investor. Holding too many funds is not good. Your choice of type of fund must depend on your investment goal, time horizon, risk appetite and so on. Below we discuss a set of do's and don'ts for investment in mutual funds.
Don't: Invest in a fund without reviewing its performance and offer document
Don't simply invest in a fund because your friend has bought it recently or it was recommended on a website or TV program. In a market boom most funds will do well but that doesn't suggest that all of them will consistently perform.
Do: Select a fund with proven track record and go through its offer document
The Scheme Information Document is the rule book of the fund. It is the most reliable source for getting information on facts such as the fund's objective of investment, what kind of shares it will invest in, proportion of investment in various market caps in case of an equity fund, expense ratio and so on. Also read the most recent Fact Sheet of the fund to get an idea of the current composition of the fund's holdings and current fund manager. You can find all relevant documents on the mutual fund's website.
Don't: Blindly chase a fund for its current performance or overlook another for its lackluster performance in the near past.
Track the fund's performance in a market boom and market crash. Invest in a fund with at least 5 years of performance. Stay away from NFOs if you are a new to mutual funds. Most new funds don't really offer anything new; they just have fancy names with slight variation in the portfolio composition. Check the fund manager's credibility. Is he/she an experienced one? Are there others funds he/she has been managing successfully? Is the AMC known for a good set of fund managing team and well performing funds?
Don't check your fund's NAV every day or week or even month. NAV may fluctuate in the short term but all that matters is the percentage gain or loss. Over a period short term losses cancel out with gains. So keep your cool and don't rush to sell your units fearing you'll lose your money provided you are confident that you made the investment choice after proper research.
Do: Hold your peace
Monitor your fund's performance once a year. Withdraw from it only if its performance has been poor compared to its peers for over a year or so owing to fundamental factors such as change in composition of portfolio, change in fund manager, etc.
Don't: Invest huge amounts all at once
If you're making a lump sum investment, don't put all the money allocated for a goal into a fund all at once. You risk buying units at a costlier price and possibly your whole investment if in case it is a bad fund.
Do: Invest via SIPs
Avail the benefit of rupee cost averaging by investing amounts periodically through Systematic Investment Plans. If you must invest in lump sum break the amount up and invest after a time interval.
Don't: Simply chase performance
That a fund has been performing consistently does not guarantee that its performance will be great when you want to redeem units because markets are subject to volatility.
Do: Invest according to your risk profile
Your risk appetite will depend on your investment goal, time horizon and age. If you need the money in say less than 3 years and if it meant for an important goal that cannot missed like your child's education you might consider investing in a balanced fund instead of an equity fund. Similarly if you are a senior citizen you might prefer less allocation to equity in your portfolio. Unless you are in need of regular income choose to reinvest dividends.
Don't: Ignore expenses
Mutual funds charge fee from investors for covering management expenses, transaction charges and so on. Funds also charge an exit load for withdrawal before a specified time period. Although charges alone don't matter much, if you must choose among equally well performing funds go with the one having lower expense ratio.
Do: Compare expense ratios
Especially in case of index funds which are passively managed expense ratio is a determinant for fund selection. Index funds simply track an index so the returns of all funds tracking a particular index are expected to be identical. Here you can choose the fund with lower expense ratio. In the long term high expense ratios can eat away a significant portion of you returns due to the effect of compounding.