What should investors do to ensure that they invest correctly in mutual funds and what are the mistakes they should be wary of?
Year 2017 was good for Indian markets and financialisation of assets finally started happening. In my sessions, over the last year, I noticed immense interest from people in mutual funds. It was good to receive so many queries on mutual funds compared to the earlier years when all doubts used to be around insurance or loans. However, what is also coming across is that investors are making the same mistakes as they did while buying insurance. But remember, you can’t make the same mistake twice. The second time, it’s not a mistake—it’s a choice. And these choices ultimately don’t make money for people. So what are the mistakes that investors need to be wary of?
First, as was (and is) in the case of insurance, people are investing in mutual funds without goal planning. Many of the session participants ask me about the best funds to invest in, but when asked about the goal for which the investment is being made, they have vague answers like “for growth", “for investment", and what not. These goals are not specific, accurate or time bound. Without knowing the investment horizon, one would end up choosing the wrong fund. For instance, many people are investing in equity funds with an investment horizon of 2-3 years, which is too short a time for equity investments.
Second, there is a tendency to buy a new fund each time one invests. And more often than not, this would be the best-performing fund in the recent past. It is not uncommon to come across people who have 15-20 insurance policies and I have also met people who have 60-80 policies. These policies have been acquired over time for 80C investments and obviously the insurance agent got the investor to split the policies for better commission. I have been meeting investors who hold five to six different equity-linked savings schemes (ELSS) and eight to nine equity funds. This is diversification for the sake of diversification, which doesn’t lead to better returns. The better way to choose funds, based on consistent risk-adjusted returns over long term, is being ignored.
Third, I find that the allocation to market-linked investments in the overall portfolio of most investors would be on the lower side and very few would have more than 20% in these instruments. It is well known that most people tend to underinsure themselves, focusing more on the amount that they will receive from the policy rather than the insurance cover. A minor allocation to equities is really not going to make a significant difference in increasing one’s wealth and hence investors must focus on the right proportion of assets in their portfolio.
The fourth mistake I see is that, many investors believe equity funds will deliver 15% return on a yearly basis. Most investment-liked insurance products are also bought with the view that they give an assured double-digit return at maturity. Investors need to know that fixed deposits and small savings schemes are the only schemes that give guaranteed returns.
And finally, the persistency levels—that is, how long customers stay invested. A lot of mutual fund investors have come in over the past 1 year and it remains to be seen how long they will stay invested if the markets fall. The persistency ratio of the Indian life insurance industry is low (bit.ly/2qhNFvV) and only one-third of all life insurance policies bought are renewed from the 5th year. Two-third of the policies lapse mainly because people stop paying, as they realize that these policies are not going to give them the expected returns. Customers buy policies without adequate research and understanding. Agents too, on their part, hard sell polices with all sorts of promises. So what should investors do to ensure that they invest correctly in mutual funds?
1) Link the mutual fund investment to a goal, so that the right category of fund is chosen.
2) Figure out your risk-taking capacity and have the right asset allocation in place.
3) Spend time understanding funds and do adequate research before investing. Remember, mutual funds are market-linked instruments and remaining invested for long term is the key to making good returns in equities.
4) Do not have more than five or six equity funds. Additional investments should be made into existing funds. Similarly, no more than two ELSS schemes should be invested into.
5) Do not invest into funds just because they are being offered at Rs10. The return on investment is more important than the net asset value.
On their part, mutual funds would need to do a lot more to educate customers on the right way to invest. I find that the two main issues that bog investors are, how to choose a fund and where can one get the right information about mutual funds. There is an information explosion on the internet, which leaves most consumers confused. The “Mutual Funds, sahi hai" campaign should now move from focusing on the ease and benefits of investing in mutual funds, to how people can choose funds. The Association of Mutual Funds of India (Amfi) could have the data on funds performance based on 7-10 years risk-adjusted returns listed on its website, to help investors choose funds better. To ensure better persistency and happier investors, Mutual funds sahi hai needs to transition to ‘mutual fund investment ka sahi tarika’ (the right way to invest in mutual funds).
Mrin Agarwal is financial educator; founder director, Finsafe India Pvt. Ltd; and co-founder, Womantra
Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.
Never miss a story! Stay connected and informed with Mint.
our App Now!!