Watch out for pitfalls when investing in equity MF schemes

The interest of investors has been shifting from direct equity investing to equity mutual funds over the last few years. Though this is a welcome trend, investors should avoid certain mistakes while making investments as well as while staying invested in equity MFs. Let us discuss some of the major mistakes which the investors in equity MFs should allow so as to make their ride smooth.

Short-term investment, consistent returns

Equity investment gets you higher returns, but the returns are not generated year after year consistently like your fixed deposits. The returns in equity investments are most volatile in both ways. If your investment horizon is less than seven years, there is a probability of you losing your capital as well. The long ride on equity becomes smooth and whole of the volatility is evened out in the long run, and the shocks of roller-coaster ride are not felt.

Investing without mapping financial goals

You need to map your investments with your particular financial goal. The goal may be buying of house, education, and marriage of children or even it may be retirement as well. If there is no goal the investments can be for wealth creation itself. The investment product to be chosen depends on the duration and flexibility of your goal. Your foreign trip or house buying can wait but the education or marriage of your children cannot wait, so the choice of the product is interlinked with your financial goal. Since the corpus invested in equity has to be moved to safer investment products as the goal approaches, you will not be able to do this unless your investments are mapped with your specific goal.

Investing in dividends options

Any dividend paid to you in any mutual fund scheme is effectively paid out of NAV (Net Asset Value) of your fund and thus goes out of your pocket. The NAV of your scheme comes down after the dividend to that extent. Since all the dividends distributed by MF schemes are subject to dividend distribution tax, it does not make sense for you to opt for dividends option.

The dividend distribution tax on equity oriented schemes is 10% which also needs to be grossed up. After taking into account the benefit of initial exemption of Rs 1 lakh, the effective tax rate on long-term capital gains is lower than the effective dividend distribution tax. So it makes sense for you to opt for growth option with a systematic withdrawal plan to withdraw money which you need periodically instead of choosing dividend option.

Not reviewing or over reviewing

Reviewing your investment periodically is the most important part of the investment journey. You need to review the performance of your investments vis a vis your goals at regular intervals. Based on the performance of your scheme vis a vis your goals you can take the decision to shift your investments to another equity scheme or increase the investment amount.

Likewise, over-reviewing is also injurious. You should not look at the performance of your equity schemes every month and take the corrective steps. The ideal review period in my opinion is one year; no less, no more.

Non-diversification or over diversification in fund houses and schemes

There are investors who will invest in many schemes with duplication of similar schemes as regards to category and which reduces the benefits accruing due to diversification. Ideally, you should not have more than five equity schemes in your portfolio. Likewise, you should not just focus on only one or two schemes. Based on your goals, your investments in equity MF should be spread across reputed MF houses and the broader category of schemes evenly such as large cap, mid cap, small cap, tax saving and, aggressive hybrid equity schemes.

Expecting unrealistic returns

People want unrealistic returns from their investments in equity schemes which is not possible. Be realistic and expect realistic returns from your investments. Your investments in mutual funds should give you minimum of inflation 6%-plus returns in the long run, and you should be happy with such returns which are better than other investment class.

Investing in mutual funds based on NAV

People equate investing in equity schemes with investing in equity shares and thus go by the value of NAV without realising that the higher NAV represents the value of the stocks held by the scheme. So people go for NFO (New Fund offer) which offers NAV of Rs 10 without realising the relevance of the NAV in MF investing.

Trying to time the market

People generally get panicky during corrections in the equity markets and stop their investments through systematic investment plans (SIPs). It is always advisable never to try to time the market but give time in the market if you wish to reap the benefits of equity investing. People generally act irrationally during the correction or bear market. When they see their profits going down they stop their SIPs when in reality that is the time when one should make the maximum of the correction and should stay put if not put more money in the schemes.

Going overboard on one asset class

While making investments in equity one should not forget the principle of asset allocation and rebalancing of the investments periodically. If you follow the principle of asset allocation you will certainly be able to maximise your returns on your investments due to periodical asset rebalancing to maintain the predetermined asset allocation. So in case one does not follow the asset allocation even one major correction in the asset class may result in wiping out the profits and may result in losses as well.

The writer is a tax and investment expert