Do you select funds with the highest past returns?
Common Mistake 1: Investing in a fund with highest past returns
By far this is the most popular method for selecting a fund. It is like driving a car looking at the rear view mirror. It's misleading, inadequate and risky. Misleading, because it has the biases of when you started and how the markets are doing at the time of measuring the performance. It's inadequate because it does not tell us how much risk the fund manager is taking and whether the fund is likely to perform in the future. It’s risky because funds that give the highest returns today have stocks that are overvalued and likely to correct or stagnate.
Do you diversify in 3-4 Funds that have delivered the highest past returns?
Common Mistake 2: 'Diversifying' in 3-4 recent Top Performing Funds
This is perhaps the most popular way of diversifying, but its ineffective. It ends up shortlisting funds with a very similar process (the rationale for selecting stocks in the portfolio) that resulted in all these funds outperforming together. For the very same reasons, these funds will someday start underperforming together making investors very uncomfortable and triggering an exit. This defeats the very purpose of investing in multiple funds which is safety through diversification.
Do you diversify by investing in Large, Mid, Multicap, Small Cap and Sectoral fund?
Common Mistake 3: 'Diversifying' in in 1 Large-cap, 1 Mid-cap, 1 Multi-cap and 1 Sectoral Fund.
Many investors make/follow this recommendation with the hope of having a diversified portfolio. The idea of investing in a Mutual Fund is to use the fund managers’ expertise in picking stocks. In a Multi-cap fund the fund manager can pick large, mid or small cap stocks and stocks from any sector whenever they are attractive. Having chosen a multi-cap fund renders choosing other cap/sectoral funds redundant and probably counter-productive.
As markets are volatile investors need real diversification to reduce risk. This is completely compromised by these two very common mistakes.
Mutual Fund sahi hai magar sahi advice bahut zaroori hai. Investing in Mutual funds can help you meet your financial goals more efficiently provided you do it the right way. And that requires competent advice you can trust.