Every day we come across advertisements in newspapers, magazines, hoardings, TV and internet and even on trains, buses and metros telling us to invest in mutual funds.
But before you invest you must know the mistakes which are to be avoided. Knowing them will make your investment journey smooth and will help you reach your investment destination or goal.
Let us look at these 6 mistakes which you should avoid
1. Investing without a goal or a financial plan
Investing without a goal is like racing without a finish line.
This is the most basic. Like the foundation stone of a building. It is important to think and plan for achieving a financial goal.
Example: A person aged 24 years who has just started working can have a goal to buy a car or house after few years OR can have a goal to save money for one’s marriage and then the expenses of rearing children as well funding their school and college expenses OR can have a goal of saving money for one’s retirement
Whatever the goal, it is important to plan and allocate money as per the various goals.
2. Investing without a budget.
Investing without a budget is like flying a plane without a fuel gauge.
If you don’t balance your earnings and spending, you will never save enough to invest which is a sure way to crash-land since you will never know when you ran out of fuel.
List down your monthly net income and the items and amount you spend every month. You must make a budget plan to ensure that you do not overspend by being emotional and impulsive.
Experts call this as a “Cash flow plan” which will capture each item of cash inflow and outflow.
You can do this by writing down in a diary or even entering the details in Microsoft excel in your PC.
Some people find it difficult even to save 10% of their net income because they are impulsive, emotional and like to live with comforts, whereas some others save more than 50% of their net income because they are disciplined, conservative and spend smartly only when required on the most basic needs.
You must decide on the level of savings that you are comfortable with as per your goal.
In addition to the monthly savings, whenever you get a lump sum amount such as bonus, gifts, inheritance, lottery etc. you must invest that as well.
Remember however the more you save today, the better your future will be as money saved and invested in mutual funds will compound and grow over time.
Hence it is very important to make and stick to the budget every month with full discipline. Only this will help you achieve your long term goals.
3. Investing without understanding your risk-taking ability
Investing without knowing your risk-taking ability is like buying a garment without knowing your size.
You do not know whether it is the right size for you and whether you will be comfortable wearing it.
A general rule of thumb is that the money which do not need for the next five years or more can be invested in equity mutual funds, while the money which you may need within the next five years should be invested in debt mutual funds and the money which you may require in the next six months should be invested in money market or liquid mutual funds
While this is a general rule, it is always recommended that you take a risk-profiling test which will scientifically bring out your risk taking ability.
Usually such tests do not take more than fifteen minutes and are available with any registered financial planner or a mutual fund distributor/broker.
The result of the test is that you will get to know your exact risk profile.
(The four basic types of risk profiles are cautious, conservative, moderate and aggressive)
Each risk profile will tell you how much percentage of your total money should be invested in equity, debt, liquid and in gold.
4. Investing in mutual funds without doing homework
Investing in mutual funds without doing homework is like trying to drive a car without obtaining a driving license.
“Never buy anything without doing adequate homework” is a generally accepted philosophy. This holds good for mutual funds as well.
After you have identified your goals, monthly investment budget and your risk profile the next step is to figure out which mutual fund schemes are suitable for you.
For this you can approach your financial planner or your mutual fund distributor/ broker who will advise you on select good long-term performing schemes.
You should not spread your investments in more than 3 or 4 top performing funds. Since it will increase your paperwork as well as tracking efforts without increasing your returns (example: if you are investing Rs 20,000 per month, spread it equally amongst the top 3 or 4 funds)
5. Not doing SIP in mutual funds
This is another major mistake which is completely avoidable.
Equity, balanced and tax saving (ELSS) schemes hold a portfolio of equity stocks and prices of equity stocks are never constant and move up or down based on various company-specific as well as general market and economic factors.
Hence the prices of mutual fund schemes (called as net asset value -NAV) keep moving up or down.
The best and only sensible long-term method of investing in mutual funds is through the SIP route (systematic investment plan)
The benefit is that when equity stocks and fund NAVs are down, you get more units for the same amount of investment and conversely when equity stocks and fund NAVs are down, you get lesser units for the same amount of investment.
Hence over the long-term, you get an average price and hence you are spared the emotionally demanding option of investing all your money only at a particular constant price.
Another benefit is that since you earn income every month, the SIP facility will ensure that a fixed sum of money is debited from your bank account, on a particular date of your choice every month.
This will ensure that you do not have to remember to invest every month as the SIP will put your investment on auto-pilot.
So earn, save, and invest and then finally… Spend a little… every month!!
Many people do reverse… they earn, spend and finally… invest a little… every month!
What do you think is the right approach to build your future..?
6. Not having the long-term in mind and being impatient.
This is a mistake which many investors make. This is more to do with their temperament and personality than with any other factor.
Many investors are temperamentally not suited as they keep watching the stock market and mutual fund NAVs regularly and remain confused about their decisions.
It is very strongly recommended that like your goals, you need to also give a sufficiently long time for your mutual fund investments to give you returns. This means that when you invest in equity mutual funds through the SIP route, you must think of your goals which are 10 or 20 or even 30 years away and you must be patient with your investments.
History has shown that in the long-term the Indian equity markets have given returns in the range of 13% to 16% p.a. (The time period for this is the movement of BSE Sensex from 1978 when it was 100 till January 2016 when it is around 24,000)
However it should be noted that the returns are not guaranteed and may vary based on the market movements.
Since, you have a long-term goal in mind the short-term market movements should not affect you and you need to remain calm and patient. Patience always pays.