|
|||
Money is a very strange
thing - human beings make rational decisions while dealing with most
aspects of life but make serious errors of judgment when it comes to
dealing with money - while dealing with different aspects of money and
finance including earning, protecting, budgeting, saving, spending,
leveraging, investing and insuring.
Completely rational investors take totally irrational decisions when
part of crowd - their own individual rational minds come down many
levels to the irrational level of the crowd. Many a times, rational
intelligent people commit simple mistakes while making investment
decisions in common stocks. And those mistakes get compounded while
investing in mutual funds. Fund managers, marketers as well as the
markets themselves have its own ways of finding and exploiting human
weaknesses. I try to explain and explore the 10 most common mistakes
which investors usually commit while investing in Mutual Funds (MF).
Mistake 1: Imagining that Low NAV is Cheap
This is one of the silliest mistakes which an investor commits while
investing in Mutual Funds. The investor feels that a fund with a lower
Net Asset Value (NAV) is cheap compared to a fund with a higher NAV.
There is nothing further from truth. This mistake stems from the simple
fact of a person who does not know the meaning of mutual fund. This
blunder is because the investor neither understands nor appreciates the
difference between price and value. A MF unit in itself has no value -
it is "not" an asset like a house property, bond, equity stock, gold
etc. Yes, the MF unit in itself simply has no value on its own - it
derives the value from the underlying asset which it owns. The NAV is
nothing but the value of the total underlying assets of the fund divided
by the number of units. For example, if a fund has equity shares in
different companies who current value sums up to Rs.1000 crores and has
50 crore units then its NAV is Rs.20 per unit while another fund whose
current total value of equity shares is again Rs.1000 crores but has 100
crore units then its NAV amounts to Rs.10 per unit. Does it mean that
the second fund with a NAV of Rs.10 per unit is cheaper than the one
with Rs.20 per unit? Certainly not. This is because the total value of
the assets of each fund is the same Rs.1000 crores - in the first case
it is distributed among 50 crore unit holders while in the second case
it is 100 crore unit holders.
Mistake 2: Too costly or very cheap
This is a continuation of the first mistake. A MF unit can't be costly
or cheap - it is not an asset in itself which can be costly or cheap -
it derives its value from the underlying investment. If the value of the
underlying investment goes up then the NAV will go up and vice versa.
For example, there are two funds - A and B. Now, the NAV of Fund A is
Rs.10 per unit while the NAV of Fund B is Rs.50 per unit. Does this mean
that Fund A is cheaper than Fund B? Not at all. The NAV simply means
that Fund A is holding such assets in totality which when divided by the
total number of units' results in a NAV of Rs.10 and ditto computation
for Fund B which results in NAV of Rs.50. Further assume that the
portfolio of both these Funds is exactly similar. In that case, a 20%
rise in the value of the portfolio will result in a commensurate 20%
increase in the value of the NAV of the Funds - Rs.2 in the case of Fund
A while Rs.10 in the case of Fund B.
Hence, while investing in MFs, don't look at the price of the NAV but
rather the underlying value which is derived from the portfolio of the
Fund.
Mistake 3: Buying MF NFO at "par"
This is another derivative of the first two mistakes - an investor can't
be more foolish when he / she invest in a MF- New Fund Offer (NFO)
simply because it is available at "par value." As explained above, the
MF- NAV is meaningless in itself as it is merely the value of the
underlying asset. Therefore, buying a MF unit because it is available at
par value would be one of the silliest mistakes which an investor can
commit with its money. Remember that MF unit is not a scarce resource - a
MF can create as many units as the inflows into the fund - it has to
just print the units and send it to the investor - similar to how the
Government can infinitely print currency notes. The same is not true for
an equity share because a company can't just print its shares without
diluting the holding of its assets.
Mistake 4: Fancy Funds, fads and fantasies:
Many new funds and schemes prop up during times of exuberance. Banking
Funds will be launched when banking stocks have performed well,
infrastructure funds when the infrastructure stocks are rising or IT
funds when the technology boom is underway, so on and so forth. These
sector funds follow simply smart tactics to collect money from the
gullible investors. No sector or theme continuously performs well over a
longer term. Even worse than it, a sector fund is generally launched
after the sector has already performed well because the fund has to show
good past performance to attract fresh investor money. And by applying
the "law of averages," it becomes more likely that the sectors which
have already performed well in the past will actually not perform so
well in the future. Hence, never fall prey to fund gimmicks and invest
in sector or theme based funds.
Mistake 5: Ignoring Index Funds
This is another very common mistake which MF investors commit - ignoring
a simple low cost index fund in favour of the high cost actively
managed fund. You will get these kind of advice most of the time from
majority of the people that equity investments are for the experts and
if you don't know how to pick your stocks then you should entrust your
money to the expert fund manger etc. However, I dare to say that these
are probably one of the most useless advice that one can ever receive.
Hold on, I am not saying that you don't entrust your money to the
experts and start picking your own stocks - no there may not be a bigger
financial suicide than this. I just humbly submit that it's very
difficult, if not impossible, to beat the stock market indices
consistently over a longer period of time. If that were not the case,
then why over a period of a decade or more, approximately 75% of all
"actively" managed stock funds underperform the passively constructed
stock indices. The fact of the matter is that most people have no reason
whatsoever to believe that they can pick winning stocks or time the
markets and their success at it would be the same as it would be like
throwing darts at the financial pages. I would like to quote Dr. William
Bernstein who told that "there are two kinds of investors, be they
large or small: those who don't know where the market is headed, and
those who don't know that they don't know where the market is headed.
Then again, there is a third type of investor - the investment
professional, who indeed knows that he or she doesn't know, but whose
livelihood depends upon appearing to know where the market is headed".
Nothing more succinctly explains the real world of professional
investing and stock picking. Mr. Merton Miller, Nobel laureate and
professor of Economics of Chicago commented that "if there are 10000
people looking at the stocks and trying to pick winners, one in 10000 is
going to score, by chance alone, a great coup, and that's all that's
going on. It's a game, it's a chance operation, and people think they
are doing something purposeful, but they're really not". Then I would
quote Mr. Rex Sinquefield, co-author of Stocks, bonds, ills and
inflation that "we all know that active management fees are high. Poor
performance does not come cheap. You have to pay dearly for it". Thus,
active fund management is nothing but paying heavy fees for
underperforming the passive indices! Then for the investors who are
always on the look out for the next hot fund, the next great sector fund
or so, Bethany McLean, columnist for Fortune magazine wrote "skepticism
about past returns is crucial, the truth is, much as you may wish you
could know which funds will be hot, you can't and neither can the
legions of advisors and publications that claim they can. That's why
building a portfolio around index funds isn't really settling for the
average. It's just refusing to believe in magic." And let me further
quote Mr. Jon Bogle, founder and retired CEO of the Vanguard group
"Index funds eliminate the risks of individual stocks, market sectors,
and manger selection. Only stock market risks remain". In other words,
when you invest in a passively managed index fund than all the risk
relating to the fund manager, his / her stock selection and market
timing, individual sectors etc all go and the only risk which remains is
the risk of the whole stock market and that is precisely the risk which
would like to expose yourself to when you invest in equities. Mr.
Nicholas Taleb has written an excellent book titled "Fooled by
randomness" wherein he explains the role of chance in life and in the
markets and I will recommend that book to anyone who believes that he /
she can consistently pick winning stocks and / or time the markets to
perfection. Last but not the least I would like to jot the words of the
great legendary investor Mr. Warren Buffet who once said that "most
investors, both institutional and individual, will find the best way to
own common stocks is through an index fund that charges minimal fees.
Those following this path are sure to bear the net results (after fees
and expenses) delivered by the great majority of investment
professionals". The conclusion therefore is that there is no reason for
you or anybody else to believe that they can pick winning stocks or time
the markets. Hence, the best solution for any equity investor is to
stock into low cost passively managed index funds because year after
year they would beat at least 75% of the actively managed funds and over
the longer term in most probabilities beat almost all the funds.
Mistake 6: Selling Winning Funds while sticking on to the loosing ones
This is a grave mistake which people commit with MFs, equity stocks,
other kind of investments as well as in many real life situations -
sticking on to the loosing ones while selling the winning ones. It's
important to be realistic about investments that are performing badly
including MFs. Recognizing the losers is hard because it's also an
acknowledgement of your own mistake. But, it’s important to accept and
book a loss or else future loss would be even higher.
Mistake 7: Fund Churning
This is a common advice which might be showered on you by your MF
Distributor. Instead of churning your fund just churn the MF distributor
who gave you that advice. Distributors love the churning game - simply
because it gives them extra commissions and fees while it gives you
extra income tax, expenses and most probably a sub optimal fund.
Mistake 8: Paying credence to recent past performance
A common mistake which a fund investor does is by looking at recent past
performance. Past performance is certainly important but if you give
too much importance to "continuous performance by looking at daily NAV"
then you are inviting unnecessary worries for you in the form of selling
a good fund and moving to a not so good fund, the MF churning advisors,
income tax, higher commissions and other costs etc.
Mistake 9: The Dividend Temptation
You may be advised by the MF Distributors and marketers that a fund has
declared dividend and it is trading cum-dividend and therefore take the
advantage of earning free dividends. But, there is no free lunch in this
world - particularly not in the world of investments and mutual funds.
The dividend which a fund pays to an investor is immediately reduced
from the NAV of the fund. So what is the sense of the dividend when on
one hand you receive the cash and on other hand your NAV falls by that
much amount? On the contrary, I would say that don't invest in a fund
which has declared lofty dividends because that is against your purpose
of investments - you are entrusting your money to the Fund Manager to
manage it on your behalf and not to return back to you! (unless ofcourse
you require regular income in the form of dividends).
Mistake 10: Not Understanding the Type of Funds
The primary purpose of MFs is to make your life simpler by investing
your money on your behalf. However, actually they have made your life
difficult by making available a plethora of different categories and
schemes. Hence, before biting the bullet get acquainted with which
category of Fund you are investing in - Equity, Fixed Income, Balanced,
Commodity and within them the various sub-sets like sector, theme, gilt,
income, short-term, liquid etc in which you are investing.
The risk, expected return, income tax, expenses, required time horizon
are immensely different in each of those categories. So don't commit the
unpardonable mistake of investing your money in a fund without actually
knowing where and in which asset class it is going to deploy your
money.
Market is a place which will test your patience and character. Many
times you might have bought the right stock or Mutual Fund for all the
right reasons at the right price but it simply refuses to go up for a
long period of time - just hang on to it because the day you get
frustrated and sell it off, there are chances it will then start
rising. Hence, patience and character are key virtues which will be
repeatedly tested by the market.
To conclude, there are many simple and avoidable mistakes which
investors mutually commit while investing in mutual funds and I have
tried to explain some of the most common ones of them. Kindly note, that
simple logical things work far better in the market place rather than
complex algorithms, theorems, valuations principles, DCF etc. And there
is no other place to test your virtues than the market - be it common
sense, logical thinking, patience, perseverance, mental balance,
emotional intelligence, performing under stress etc. All the qualities
which make a successful human being will be tested by the market - it
has its own method of finding and exploiting human weaknesses. Investing
is not about beating the market or anybody else, its simply beating
your own self, your own negative traits and once you are able to master
your own self and become a complete human being, then only you would
also become a successful investor. Articulate your investment goals,
know your time horizon, recognize your risk appetite, understand your
need for income and growth, invest regularly although it may be in small
lots, do your thinking and research and after doing it don't panic just
because the market went against you, accept your mistakes and flaws and
avoid the common mutual mistakes which investors mutually commit while
investing in Mutual Funds so as to embark on becoming a successful
Mutual Fund investor and a complete human being.
Read more at: http://www.moneycontrol.com/news/mf-experts/mutual-funds-10-commonly-committed-mistakes_723728.html?utm_source=ref_article
Read more at: http://www.moneycontrol.com/news/mf-experts/mutual-funds-10-commonly-committed-mistakes_723728.html?utm_source=ref_article
Money is a very strange
thing - human beings make rational decisions while dealing with most
aspects of life but make serious errors of judgment when it comes to
dealing with money - while dealing with different aspects of money and
finance including earning, protecting, budgeting, saving, spending,
leveraging, investing and insuring.
Completely rational investors take totally irrational decisions when
part of crowd - their own individual rational minds come down many
levels to the irrational level of the crowd. Many a times, rational
intelligent people commit simple mistakes while making investment
decisions in common stocks. And those mistakes get compounded while
investing in mutual funds. Fund managers, marketers as well as the
markets themselves have its own ways of finding and exploiting human
weaknesses. I try to explain and explore the 10 most common mistakes
which investors usually commit while investing in Mutual Funds (MF).
Mistake 1: Imagining that Low NAV is Cheap
This is one of the silliest mistakes which an investor commits while
investing in Mutual Funds. The investor feels that a fund with a lower
Net Asset Value (NAV) is cheap compared to a fund with a higher NAV.
There is nothing further from truth. This mistake stems from the simple
fact of a person who does not know the meaning of mutual fund. This
blunder is because the investor neither understands nor appreciates the
difference between price and value. A MF unit in itself has no value -
it is "not" an asset like a house property, bond, equity stock, gold
etc. Yes, the MF unit in itself simply has no value on its own - it
derives the value from the underlying asset which it owns. The NAV is
nothing but the value of the total underlying assets of the fund divided
by the number of units. For example, if a fund has equity shares in
different companies who current value sums up to Rs.1000 crores and has
50 crore units then its NAV is Rs.20 per unit while another fund whose
current total value of equity shares is again Rs.1000 crores but has 100
crore units then its NAV amounts to Rs.10 per unit. Does it mean that
the second fund with a NAV of Rs.10 per unit is cheaper than the one
with Rs.20 per unit? Certainly not. This is because the total value of
the assets of each fund is the same Rs.1000 crores - in the first case
it is distributed among 50 crore unit holders while in the second case
it is 100 crore unit holders.
Mistake 2: Too costly or very cheap
This is a continuation of the first mistake. A MF unit can't be costly
or cheap - it is not an asset in itself which can be costly or cheap -
it derives its value from the underlying investment. If the value of the
underlying investment goes up then the NAV will go up and vice versa.
For example, there are two funds - A and B. Now, the NAV of Fund A is
Rs.10 per unit while the NAV of Fund B is Rs.50 per unit. Does this mean
that Fund A is cheaper than Fund B? Not at all. The NAV simply means
that Fund A is holding such assets in totality which when divided by the
total number of units' results in a NAV of Rs.10 and ditto computation
for Fund B which results in NAV of Rs.50. Further assume that the
portfolio of both these Funds is exactly similar. In that case, a 20%
rise in the value of the portfolio will result in a commensurate 20%
increase in the value of the NAV of the Funds - Rs.2 in the case of Fund
A while Rs.10 in the case of Fund B.
Hence, while investing in MFs, don't look at the price of the NAV but
rather the underlying value which is derived from the portfolio of the
Fund.
Mistake 3: Buying MF NFO at "par"
This is another derivative of the first two mistakes - an investor can't
be more foolish when he / she invest in a MF- New Fund Offer (NFO)
simply because it is available at "par value." As explained above, the
MF- NAV is meaningless in itself as it is merely the value of the
underlying asset. Therefore, buying a MF unit because it is available at
par value would be one of the silliest mistakes which an investor can
commit with its money. Remember that MF unit is not a scarce resource - a
MF can create as many units as the inflows into the fund - it has to
just print the units and send it to the investor - similar to how the
Government can infinitely print currency notes. The same is not true for
an equity share because a company can't just print its shares without
diluting the holding of its assets.
Mistake 4: Fancy Funds, fads and fantasies:
Many new funds and schemes prop up during times of exuberance. Banking
Funds will be launched when banking stocks have performed well,
infrastructure funds when the infrastructure stocks are rising or IT
funds when the technology boom is underway, so on and so forth. These
sector funds follow simply smart tactics to collect money from the
gullible investors. No sector or theme continuously performs well over a
longer term. Even worse than it, a sector fund is generally launched
after the sector has already performed well because the fund has to show
good past performance to attract fresh investor money. And by applying
the "law of averages," it becomes more likely that the sectors which
have already performed well in the past will actually not perform so
well in the future. Hence, never fall prey to fund gimmicks and invest
in sector or theme based funds.
Mistake 5: Ignoring Index Funds
This is another very common mistake which MF investors commit - ignoring
a simple low cost index fund in favour of the high cost actively
managed fund. You will get these kind of advice most of the time from
majority of the people that equity investments are for the experts and
if you don't know how to pick your stocks then you should entrust your
money to the expert fund manger etc. However, I dare to say that these
are probably one of the most useless advice that one can ever receive.
Hold on, I am not saying that you don't entrust your money to the
experts and start picking your own stocks - no there may not be a bigger
financial suicide than this. I just humbly submit that it's very
difficult, if not impossible, to beat the stock market indices
consistently over a longer period of time. If that were not the case,
then why over a period of a decade or more, approximately 75% of all
"actively" managed stock funds underperform the passively constructed
stock indices. The fact of the matter is that most people have no reason
whatsoever to believe that they can pick winning stocks or time the
markets and their success at it would be the same as it would be like
throwing darts at the financial pages. I would like to quote Dr. William
Bernstein who told that "there are two kinds of investors, be they
large or small: those who don't know where the market is headed, and
those who don't know that they don't know where the market is headed.
Then again, there is a third type of investor - the investment
professional, who indeed knows that he or she doesn't know, but whose
livelihood depends upon appearing to know where the market is headed".
Nothing more succinctly explains the real world of professional
investing and stock picking. Mr. Merton Miller, Nobel laureate and
professor of Economics of Chicago commented that "if there are 10000
people looking at the stocks and trying to pick winners, one in 10000 is
going to score, by chance alone, a great coup, and that's all that's
going on. It's a game, it's a chance operation, and people think they
are doing something purposeful, but they're really not". Then I would
quote Mr. Rex Sinquefield, co-author of Stocks, bonds, ills and
inflation that "we all know that active management fees are high. Poor
performance does not come cheap. You have to pay dearly for it". Thus,
active fund management is nothing but paying heavy fees for
underperforming the passive indices! Then for the investors who are
always on the look out for the next hot fund, the next great sector fund
or so, Bethany McLean, columnist for Fortune magazine wrote "skepticism
about past returns is crucial, the truth is, much as you may wish you
could know which funds will be hot, you can't and neither can the
legions of advisors and publications that claim they can. That's why
building a portfolio around index funds isn't really settling for the
average. It's just refusing to believe in magic." And let me further
quote Mr. Jon Bogle, founder and retired CEO of the Vanguard group
"Index funds eliminate the risks of individual stocks, market sectors,
and manger selection. Only stock market risks remain". In other words,
when you invest in a passively managed index fund than all the risk
relating to the fund manager, his / her stock selection and market
timing, individual sectors etc all go and the only risk which remains is
the risk of the whole stock market and that is precisely the risk which
would like to expose yourself to when you invest in equities. Mr.
Nicholas Taleb has written an excellent book titled "Fooled by
randomness" wherein he explains the role of chance in life and in the
markets and I will recommend that book to anyone who believes that he /
she can consistently pick winning stocks and / or time the markets to
perfection. Last but not the least I would like to jot the words of the
great legendary investor Mr. Warren Buffet who once said that "most
investors, both institutional and individual, will find the best way to
own common stocks is through an index fund that charges minimal fees.
Those following this path are sure to bear the net results (after fees
and expenses) delivered by the great majority of investment
professionals". The conclusion therefore is that there is no reason for
you or anybody else to believe that they can pick winning stocks or time
the markets. Hence, the best solution for any equity investor is to
stock into low cost passively managed index funds because year after
year they would beat at least 75% of the actively managed funds and over
the longer term in most probabilities beat almost all the funds.
Mistake 6: Selling Winning Funds while sticking on to the loosing ones
This is a grave mistake which people commit with MFs, equity stocks,
other kind of investments as well as in many real life situations -
sticking on to the loosing ones while selling the winning ones. It's
important to be realistic about investments that are performing badly
including MFs. Recognizing the losers is hard because it's also an
acknowledgement of your own mistake. But, it’s important to accept and
book a loss or else future loss would be even higher.
Mistake 7: Fund Churning
This is a common advice which might be showered on you by your MF
Distributor. Instead of churning your fund just churn the MF distributor
who gave you that advice. Distributors love the churning game - simply
because it gives them extra commissions and fees while it gives you
extra income tax, expenses and most probably a sub optimal fund.
Mistake 8: Paying credence to recent past performance
A common mistake which a fund investor does is by looking at recent past
performance. Past performance is certainly important but if you give
too much importance to "continuous performance by looking at daily NAV"
then you are inviting unnecessary worries for you in the form of selling
a good fund and moving to a not so good fund, the MF churning advisors,
income tax, higher commissions and other costs etc.
Mistake 9: The Dividend Temptation
You may be advised by the MF Distributors and marketers that a fund has
declared dividend and it is trading cum-dividend and therefore take the
advantage of earning free dividends. But, there is no free lunch in this
world - particularly not in the world of investments and mutual funds.
The dividend which a fund pays to an investor is immediately reduced
from the NAV of the fund. So what is the sense of the dividend when on
one hand you receive the cash and on other hand your NAV falls by that
much amount? On the contrary, I would say that don't invest in a fund
which has declared lofty dividends because that is against your purpose
of investments - you are entrusting your money to the Fund Manager to
manage it on your behalf and not to return back to you! (unless ofcourse
you require regular income in the form of dividends).
Mistake 10: Not Understanding the Type of Funds
The primary purpose of MFs is to make your life simpler by investing
your money on your behalf. However, actually they have made your life
difficult by making available a plethora of different categories and
schemes. Hence, before biting the bullet get acquainted with which
category of Fund you are investing in - Equity, Fixed Income, Balanced,
Commodity and within them the various sub-sets like sector, theme, gilt,
income, short-term, liquid etc in which you are investing.
The risk, expected return, income tax, expenses, required time horizon
are immensely different in each of those categories. So don't commit the
unpardonable mistake of investing your money in a fund without actually
knowing where and in which asset class it is going to deploy your
money.
Market is a place which will test your patience and character. Many
times you might have bought the right stock or Mutual Fund for all the
right reasons at the right price but it simply refuses to go up for a
long period of time - just hang on to it because the day you get
frustrated and sell it off, there are chances it will then start
rising. Hence, patience and character are key virtues which will be
repeatedly tested by the market.
To conclude, there are many simple and avoidable mistakes which
investors mutually commit while investing in mutual funds and I have
tried to explain some of the most common ones of them. Kindly note, that
simple logical things work far better in the market place rather than
complex algorithms, theorems, valuations principles, DCF etc. And there
is no other place to test your virtues than the market - be it common
sense, logical thinking, patience, perseverance, mental balance,
emotional intelligence, performing under stress etc. All the qualities
which make a successful human being will be tested by the market - it
has its own method of finding and exploiting human weaknesses. Investing
is not about beating the market or anybody else, its simply beating
your own self, your own negative traits and once you are able to master
your own self and become a complete human being, then only you would
also become a successful investor. Articulate your investment goals,
know your time horizon, recognize your risk appetite, understand your
need for income and growth, invest regularly although it may be in small
lots, do your thinking and research and after doing it don't panic just
because the market went against you, accept your mistakes and flaws and
avoid the common mutual mistakes which investors mutually commit while
investing in Mutual Funds so as to embark on becoming a successful
Mutual Fund investor and a complete human being.
Read more at: http://www.moneycontrol.com/news/mf-experts/mutual-funds-10-commonly-committed-mistakes_723728.html?utm_source=ref_article
Read more at: http://www.moneycontrol.com/news/mf-experts/mutual-funds-10-commonly-committed-mistakes_723728.html?utm_source=ref_article
Money is a very strange
thing - human beings make rational decisions while dealing with most
aspects of life but make serious errors of judgment when it comes to
dealing with money - while dealing with different aspects of money and
finance including earning, protecting, budgeting, saving, spending,
leveraging, investing and insuring.
Completely rational investors take totally irrational decisions when
part of crowd - their own individual rational minds come down many
levels to the irrational level of the crowd. Many a times, rational
intelligent people commit simple mistakes while making investment
decisions in common stocks. And those mistakes get compounded while
investing in mutual funds. Fund managers, marketers as well as the
markets themselves have its own ways of finding and exploiting human
weaknesses. I try to explain and explore the 10 most common mistakes
which investors usually commit while investing in Mutual Funds (MF).
Mistake 1: Imagining that Low NAV is Cheap
This is one of the silliest mistakes which an investor commits while
investing in Mutual Funds. The investor feels that a fund with a lower
Net Asset Value (NAV) is cheap compared to a fund with a higher NAV.
There is nothing further from truth. This mistake stems from the simple
fact of a person who does not know the meaning of mutual fund. This
blunder is because the investor neither understands nor appreciates the
difference between price and value. A MF unit in itself has no value -
it is "not" an asset like a house property, bond, equity stock, gold
etc. Yes, the MF unit in itself simply has no value on its own - it
derives the value from the underlying asset which it owns. The NAV is
nothing but the value of the total underlying assets of the fund divided
by the number of units. For example, if a fund has equity shares in
different companies who current value sums up to Rs.1000 crores and has
50 crore units then its NAV is Rs.20 per unit while another fund whose
current total value of equity shares is again Rs.1000 crores but has 100
crore units then its NAV amounts to Rs.10 per unit. Does it mean that
the second fund with a NAV of Rs.10 per unit is cheaper than the one
with Rs.20 per unit? Certainly not. This is because the total value of
the assets of each fund is the same Rs.1000 crores - in the first case
it is distributed among 50 crore unit holders while in the second case
it is 100 crore unit holders.
Mistake 2: Too costly or very cheap
This is a continuation of the first mistake. A MF unit can't be costly
or cheap - it is not an asset in itself which can be costly or cheap -
it derives its value from the underlying investment. If the value of the
underlying investment goes up then the NAV will go up and vice versa.
For example, there are two funds - A and B. Now, the NAV of Fund A is
Rs.10 per unit while the NAV of Fund B is Rs.50 per unit. Does this mean
that Fund A is cheaper than Fund B? Not at all. The NAV simply means
that Fund A is holding such assets in totality which when divided by the
total number of units' results in a NAV of Rs.10 and ditto computation
for Fund B which results in NAV of Rs.50. Further assume that the
portfolio of both these Funds is exactly similar. In that case, a 20%
rise in the value of the portfolio will result in a commensurate 20%
increase in the value of the NAV of the Funds - Rs.2 in the case of Fund
A while Rs.10 in the case of Fund B.
Hence, while investing in MFs, don't look at the price of the NAV but
rather the underlying value which is derived from the portfolio of the
Fund.
Mistake 3: Buying MF NFO at "par"
This is another derivative of the first two mistakes - an investor can't
be more foolish when he / she invest in a MF- New Fund Offer (NFO)
simply because it is available at "par value." As explained above, the
MF- NAV is meaningless in itself as it is merely the value of the
underlying asset. Therefore, buying a MF unit because it is available at
par value would be one of the silliest mistakes which an investor can
commit with its money. Remember that MF unit is not a scarce resource - a
MF can create as many units as the inflows into the fund - it has to
just print the units and send it to the investor - similar to how the
Government can infinitely print currency notes. The same is not true for
an equity share because a company can't just print its shares without
diluting the holding of its assets.
Mistake 4: Fancy Funds, fads and fantasies:
Many new funds and schemes prop up during times of exuberance. Banking
Funds will be launched when banking stocks have performed well,
infrastructure funds when the infrastructure stocks are rising or IT
funds when the technology boom is underway, so on and so forth. These
sector funds follow simply smart tactics to collect money from the
gullible investors. No sector or theme continuously performs well over a
longer term. Even worse than it, a sector fund is generally launched
after the sector has already performed well because the fund has to show
good past performance to attract fresh investor money. And by applying
the "law of averages," it becomes more likely that the sectors which
have already performed well in the past will actually not perform so
well in the future. Hence, never fall prey to fund gimmicks and invest
in sector or theme based funds.
Mistake 5: Ignoring Index Funds
This is another very common mistake which MF investors commit - ignoring
a simple low cost index fund in favour of the high cost actively
managed fund. You will get these kind of advice most of the time from
majority of the people that equity investments are for the experts and
if you don't know how to pick your stocks then you should entrust your
money to the expert fund manger etc. However, I dare to say that these
are probably one of the most useless advice that one can ever receive.
Hold on, I am not saying that you don't entrust your money to the
experts and start picking your own stocks - no there may not be a bigger
financial suicide than this. I just humbly submit that it's very
difficult, if not impossible, to beat the stock market indices
consistently over a longer period of time. If that were not the case,
then why over a period of a decade or more, approximately 75% of all
"actively" managed stock funds underperform the passively constructed
stock indices. The fact of the matter is that most people have no reason
whatsoever to believe that they can pick winning stocks or time the
markets and their success at it would be the same as it would be like
throwing darts at the financial pages. I would like to quote Dr. William
Bernstein who told that "there are two kinds of investors, be they
large or small: those who don't know where the market is headed, and
those who don't know that they don't know where the market is headed.
Then again, there is a third type of investor - the investment
professional, who indeed knows that he or she doesn't know, but whose
livelihood depends upon appearing to know where the market is headed".
Nothing more succinctly explains the real world of professional
investing and stock picking. Mr. Merton Miller, Nobel laureate and
professor of Economics of Chicago commented that "if there are 10000
people looking at the stocks and trying to pick winners, one in 10000 is
going to score, by chance alone, a great coup, and that's all that's
going on. It's a game, it's a chance operation, and people think they
are doing something purposeful, but they're really not". Then I would
quote Mr. Rex Sinquefield, co-author of Stocks, bonds, ills and
inflation that "we all know that active management fees are high. Poor
performance does not come cheap. You have to pay dearly for it". Thus,
active fund management is nothing but paying heavy fees for
underperforming the passive indices! Then for the investors who are
always on the look out for the next hot fund, the next great sector fund
or so, Bethany McLean, columnist for Fortune magazine wrote "skepticism
about past returns is crucial, the truth is, much as you may wish you
could know which funds will be hot, you can't and neither can the
legions of advisors and publications that claim they can. That's why
building a portfolio around index funds isn't really settling for the
average. It's just refusing to believe in magic." And let me further
quote Mr. Jon Bogle, founder and retired CEO of the Vanguard group
"Index funds eliminate the risks of individual stocks, market sectors,
and manger selection. Only stock market risks remain". In other words,
when you invest in a passively managed index fund than all the risk
relating to the fund manager, his / her stock selection and market
timing, individual sectors etc all go and the only risk which remains is
the risk of the whole stock market and that is precisely the risk which
would like to expose yourself to when you invest in equities. Mr.
Nicholas Taleb has written an excellent book titled "Fooled by
randomness" wherein he explains the role of chance in life and in the
markets and I will recommend that book to anyone who believes that he /
she can consistently pick winning stocks and / or time the markets to
perfection. Last but not the least I would like to jot the words of the
great legendary investor Mr. Warren Buffet who once said that "most
investors, both institutional and individual, will find the best way to
own common stocks is through an index fund that charges minimal fees.
Those following this path are sure to bear the net results (after fees
and expenses) delivered by the great majority of investment
professionals". The conclusion therefore is that there is no reason for
you or anybody else to believe that they can pick winning stocks or time
the markets. Hence, the best solution for any equity investor is to
stock into low cost passively managed index funds because year after
year they would beat at least 75% of the actively managed funds and over
the longer term in most probabilities beat almost all the funds.
Mistake 6: Selling Winning Funds while sticking on to the loosing ones
This is a grave mistake which people commit with MFs, equity stocks,
other kind of investments as well as in many real life situations -
sticking on to the loosing ones while selling the winning ones. It's
important to be realistic about investments that are performing badly
including MFs. Recognizing the losers is hard because it's also an
acknowledgement of your own mistake. But, it’s important to accept and
book a loss or else future loss would be even higher.
Mistake 7: Fund Churning
This is a common advice which might be showered on you by your MF
Distributor. Instead of churning your fund just churn the MF distributor
who gave you that advice. Distributors love the churning game - simply
because it gives them extra commissions and fees while it gives you
extra income tax, expenses and most probably a sub optimal fund.
Mistake 8: Paying credence to recent past performance
A common mistake which a fund investor does is by looking at recent past
performance. Past performance is certainly important but if you give
too much importance to "continuous performance by looking at daily NAV"
then you are inviting unnecessary worries for you in the form of selling
a good fund and moving to a not so good fund, the MF churning advisors,
income tax, higher commissions and other costs etc.
Mistake 9: The Dividend Temptation
You may be advised by the MF Distributors and marketers that a fund has
declared dividend and it is trading cum-dividend and therefore take the
advantage of earning free dividends. But, there is no free lunch in this
world - particularly not in the world of investments and mutual funds.
The dividend which a fund pays to an investor is immediately reduced
from the NAV of the fund. So what is the sense of the dividend when on
one hand you receive the cash and on other hand your NAV falls by that
much amount? On the contrary, I would say that don't invest in a fund
which has declared lofty dividends because that is against your purpose
of investments - you are entrusting your money to the Fund Manager to
manage it on your behalf and not to return back to you! (unless ofcourse
you require regular income in the form of dividends).
Mistake 10: Not Understanding the Type of Funds
The primary purpose of MFs is to make your life simpler by investing
your money on your behalf. However, actually they have made your life
difficult by making available a plethora of different categories and
schemes. Hence, before biting the bullet get acquainted with which
category of Fund you are investing in - Equity, Fixed Income, Balanced,
Commodity and within them the various sub-sets like sector, theme, gilt,
income, short-term, liquid etc in which you are investing.
The risk, expected return, income tax, expenses, required time horizon
are immensely different in each of those categories. So don't commit the
unpardonable mistake of investing your money in a fund without actually
knowing where and in which asset class it is going to deploy your
money.
Market is a place which will test your patience and character. Many
times you might have bought the right stock or Mutual Fund for all the
right reasons at the right price but it simply refuses to go up for a
long period of time - just hang on to it because the day you get
frustrated and sell it off, there are chances it will then start
rising. Hence, patience and character are key virtues which will be
repeatedly tested by the market.
To conclude, there are many simple and avoidable mistakes which
investors mutually commit while investing in mutual funds and I have
tried to explain some of the most common ones of them. Kindly note, that
simple logical things work far better in the market place rather than
complex algorithms, theorems, valuations principles, DCF etc. And there
is no other place to test your virtues than the market - be it common
sense, logical thinking, patience, perseverance, mental balance,
emotional intelligence, performing under stress etc. All the qualities
which make a successful human being will be tested by the market - it
has its own method of finding and exploiting human weaknesses. Investing
is not about beating the market or anybody else, its simply beating
your own self, your own negative traits and once you are able to master
your own self and become a complete human being, then only you would
also become a successful investor. Articulate your investment goals,
know your time horizon, recognize your risk appetite, understand your
need for income and growth, invest regularly although it may be in small
lots, do your thinking and research and after doing it don't panic just
because the market went against you, accept your mistakes and flaws and
avoid the common mutual mistakes which investors mutually commit while
investing in Mutual Funds so as to embark on becoming a successful
Mutual Fund investor and a complete human being.
Read more at: http://www.moneycontrol.com/news/mf-experts/mutual-funds-10-commonly-committed-mistakes_723728.html?utm_source=ref_article
Read more at: http://www.moneycontrol.com/news/mf-experts/mutual-funds-10-commonly-committed-mistakes_723728.html?utm_source=ref_article
No comments:
Post a Comment