More Than 5 Ways to Get Below Average Returns in Mutual Funds
Most often tend to fetch you below-average returns on your investments, and are generally considered unhealthy. Here are more than 5 ways to avoid if you’re looking for great returns over the years.
#1 Buying Top Performing Funds Exclusively
This is one of the most common mistakes made by people investing in mutual funds, beginners and seasoned investors alike. In an attempt to maximise wealth and the overall returns on investments, people tend to buy top-performing funds exclusively and pay dearly for it. Here’s why:
- Top performing funds often don’t maintain their performance. Financial markets have a tendency to rotate in and out of styles, sectors, themes, to the extent that having an accurate read on the next wave is impossible.
- According to studies, selling a poorly performing fund in order to buy well-performing ones can cause more harm than good, as the investor stands to gain more money by staying invested in the original funds.
It is important to not fall for the trap of investing in mutual funds just because they’re top-performing currently. As we often recommend, returns should be the last reason to switch between mutual funds.
#2 Timing the market
As human beings, we’re wired to be speculative. Who doesn’t mind a get rich quick scheme? Unfortunately, the only tried and tested method of becoming wealthy through investing is by being patient and making intelligent decisions in the long term. Because of this, we tend to fall to the trap of attempting to time the markets.
- Timing the market is an attempt made by some investors to predict future market movements, and make trades accordingly.
- Timing the market also comes with an added incentive - it offers the illusion that we are smarter than others.
However, according to the efficient market theory, markets tend to stay efficient and react faster than our ability to analyze and then make decisions. This means that, by the time we have enough information to analyse and attempt to time the market, the market would have already reacted, making it too late for the attempt to “time the market”.
For instance, many want to invest in pharma industry-specific funds and stocks, in an attempt to gain from the ramifications post-COVID. However, for many of us, pharma stocks had already risen in valuations, making it too late to gain from immediate market gains.
#3 Investing in only bull markets
One of the common phrases used in the financial markets is “be fearful when others are greedy”. We’re sure you would have come across this if you’ve talked to anyone in the financial industry, or even on some popular YouTube channels. A vast majority of people understand this but almost never take advantage of this. We have a tendency to fear short term losses on paper, and thus, destroy long-term wealth.
As a rule of thumb, the best time to invest is when the prices are down - in bear markets. Contrary to conventional belief, bull markets are not the best time to invest in if you’re looking to increase your long term wealth.
Now that doesn’t mean you shouldn’t invest in bull markets at all. By this, we ask you to invest more in bear markets to build long-term wealth.
However, don’t try to time your entry for when the market is at it’s lowest. It’s highly unlikely that anyone can predict exactly how financial markets move.
#4 Selling investments when they lose money on paper
Investment genius Warren Buffett famously quoted two rules:
- Rule 1 - Never lose money.
- Rule 2 - Never forget rule 1.
Buffett, in these rules, refers to real losses (not paper losses). Selling stocks when the prices are low makes losses real. It is a widely known fact that in the long run, markets always recover.
If the heading wasn’t a clear indicator - do not panic and sell investments just because they lose money on paper. Markets always recover in the long run, don’t miss out due to fear of losses.
#5 Becoming greedy in bull markets and conservative in bear markets
Speaking of missing out, one other common mistake that beginners commit when investing in mutual funds is give in to the Fear Of Missing Out, commonly abbreviated as FOMO.
When we listen to the news or find out that the people we know are making a lot of money in the financial markets, we tend to experience FOMO, and we start chasing it. This behaviour is widely unhealthy, and would eventually lead to us destroying our long term wealth. We tend to be overly aggressive in bull markets, and super conservative in the bear markets, because, on paper, it seems like the best thing to do.
However smart investors realise this and tend to do the exact opposite. They’ll be conservative in bull markets, and aggressive in the bear markets to generate the maximum wealth possible.
#6 Leveraging Investments
"Markets can remain irrational for longer than you can stay solvent” is a popular phrase in the industry. Leverage refers to the use of debt to fund your investment in the hopes that you earn more than the interest you have to pay for the debt. This method tends to have the effect of magnifying gains but also has an equally significant chance to magnify losses.
While your long term gains are certain, it is impossible to predict exactly how much you’ll gain and when you’ll gain. By leveraging your investments, you effectively put a clock on your returns, which may either go great or extremely bad, making this an extremely risky alternative. Either you make money instantly, or you become insolvent if you leverage your investments.
#7 Using investments as collateral to take out high-cost loans
When traditional financial sources seem inadequate, there seems to be a large number of people willing to take high-cost loans with their investments as collateral.
Usually, this means that they are, at the very best, gambling on their life saving, and at worst, destroying both their present and future livelihood in a single shot. It is not advisable to use investments as collateral to take out loans.
#8 Over-investing in sectors and themes
Investing in sectors and themes has become extremely popular nowadays. As Mr Pratik Oswal mentions in his article published on the Deccan Herald, sector and theme-based funds tend to be riskier than investing in the “vanilla” diversified equity funds. Equity funds tend to be more diversified and offers better coverage of all the sectors when compared to sector-based funds.
Investing in sector and theme-based funds is inherently more volatile, as they offer significantly lesser diversification than some of the much broader funds. Investing in sector funds requires a lot of forethought. Plus, timing the market plays a significant role in building wealth through this method.
It is generally recommended to skip investing in sector funds if you’re a conservative investor. Even if you are an aggressive investor, avoid investing too much in sectors and themes. If you aren’t sure of your risk profile, Glide invest offers a free Risk Assessment survey.
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