Mutual funds remain a safe investment tool for an investor looking forward to a low-maintenance, long-term option to participate in the capital market. However, one needs to remain watchful of a few blunders that could impact the financial goal.
Low Net Asset Value (NAV) translates as more units and high returns: The NAV of a fund is akin to a share price of a company. It functions as an indicator of the price of a unit on a given day. It does not indicate the performance of the company or the fund. There is no direct link between higher and lower NAV on the performance of a mutual fund, which is related to a portfolio of securities and a fund manager’s decision-making. For instance, two separate schemes of mutual funds having NAV of Rs 20 and Rs 100, which hold the same securities will deliver the same performance. So, a high or low NAV has no effect on total investment growth. Instead of the NAV, an investor should compare schemes based on their past performance and portfolio composition.
Opting for sectoral funds: These funds have higher associated risk considering they bet on the performance of a single sector such as information technology (IT), pharma, or banking, among others. This is quite unlike equity-diversified funds. Sectoral funds are cyclical and tend to be influenced by multiple cycles of ups and downs. An individual may reap higher returns in the short run as most themes go through a market cycle. Concerning consistency on a long-term basis, sectoral funds are unsuitable for ordinary retail investors. The ideal strategy should be to start by investing in multi-cap or flexi-cap and then look forward to moving to large-cap funds.
Too many mutual funds in the portfolio: It needs to be understood that investing in every mutual fund category will not offer the best returns or portfolio diversification. About four to six schemes are enough to diversify a portfolio. Those investing a small amount should ideally go for one or two schemes maximum. In order to spot an excess of schemes, check on how many tax-savings or equity-linked savings schemes (ELSS) funds are there in a portfolio. After aligning the ELSS schemes to the overall portfolio, it gets easier to spot the excess.
Investing in mutual funds with a lower expense ratio: An expense ratio is a fee that an investor pays to fund management companies. An investor should avoid opting just because a fund has the lowest expense ratio. There are other factors also to consider such as a good track record, which is a combination of lower expenses and fund management expertise. It needs to be assessed that the fund has been consistently rewarding over a long period.
Selling mutual funds frequently: There are tax implications related to the sale and purchase of mutual funds. An investor incurs capital gains tax when mutual funds are sold, which depends on the period of holding and the type of capital asset. Ideally, it is advised to hold investments for a longer period. The longer an investor holds, the more tax is saved in the bargain.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.