What are the most common mistakes people make when choosing mutual funds?
These are some of the common mistakes made when choosing a mutual fund:
- Buying only on past performance. In any market environment, some funds produce phenomenal returns. However, last year’s best performers can be this year’s laggards. One must take other considerations into account before buying into a fund.
- Acting on tips and hunches. Since no one can consistently forecast market trends one needs to develop a consistent, disciplined approach and stick to it.
- Over diversifying. Two or three mutual funds would offer instant cost-effective diversification. Investing in more schemes will mean losing the benefits of diversification.
- Short-term horizon. For some time-periods, the market will favour diversified funds, or sector funds. When a type of fund goes out of favour, fund performance in that group will suffer, but those funds will rebound when it returns to favour.
What kind of income can I expect from a mutual fund?
Mutual funds can be conveniently used to meet various income
needs. You can invest in funds whose only purpose is to deliver regular cash
distributions. Several income/ debt oriented funds pay monthly, quarterly,
half-yearly or annual dividends.
Other funds, whose objective is growth of capital, generally pay much lower
income distributions. Since dividends are now tax-free in the hands of
investors, such schemes are becoming increasingly popular.
What are the risks of a mutual fund?
There are several risks. The first is a credit risk – the
companies in which the fund has invested might perform poorly, suffer
mismanagement or otherwise meet with misfortune. Another big risk is that some
economic, political or other development will cause the overall market to fall,
dragging down with it the holdings of your particular fund. These are risks you
would face investing in individual stocks as well; at least, mutual funds can
offer diversification.
There are some risks unique to mutual funds. The fund management, for instance,
may be doing things you don’t know about. What you think is a conservative
diversified equity fund might, in order to boost returns, invest heavily in a
particular stock or sector, thereby exposing it to the risk of a downtrend in
that particular stock.
What is net asset value?
Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the Net Asset Value of the scheme divided by the number of units outstanding on the Valuation Date.
How should I monitor my mutual fund’s performance?
You can sometimes spot potential problems and take evasive action before your mutual fund sinks in value. These could be:
- The fund’s management changes.
- Its performance slips compared to similar funds.
- The fund’s expense ratios climb.
- Its beta, a technical measure of risk, also climbs.
- Independent rating services reduce their ratings of the fund.
- It merges into another fund.
- There’s a change in management style or a change in the objective of the fund. Generally, any of these single factors automatically means a fund is slipping. But a combination of these factors calls on you to take a closer look and consider a switch.
