Avoid these common mistakes to maximize your mutual fund returns

In an era marked by market volatility and global headwinds, investing in mutual funds has emerged as a popular strategy for many Indians looking to grow their wealth. However, as Rahul Jain, Chairman and Director, Nuvama Wealth, emphasises, there are several common mistakes that investors need to be aware of to make the most of their investments.

Jain highlights that one of the most fundamental principles for building wealth through mutual funds is asset allocation. By diversifying across equities, fixed income and gold, investors can reduce risk and improve portfolio efficiency. However, many investors overlook this fundamental principle and often become blind to the risks of rising markets and miss opportunities in declining markets.

Another common mistake Jain identifies is over-diversification. While diversification is essential, holding too many investments can be detrimental to the investment portfolio. Mutual fund Investment schemes can be counterproductive. “Having too many schemes in the portfolio makes it difficult to monitor them effectively, leading to inefficiencies,” warns Jain. Investors should try to strike a balance, ensuring they are diversified enough to manage risk without spreading their investments too thin.

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Jain also advocates goal-oriented investing. Having a clear goal helps in planning cash flows and determining the right amount to invest. He also stresses the importance of seeking professional advice if investors are unsure about selecting mutual funds or monitoring their performance.

While many investors focus solely on the performance of the underlying assets, Jain argues that this is not enough. He believes that the skills of the fund manager, the processes used by the fund management team, and the consistency and quality of returns are equally critical.

When evaluating mutual funds, many investors focus primarily on past performance. However, Jain stresses the importance of looking beyond short-term performance. “While past performance is an important parameter, it is not the only one to consider,” he notes. Jain encourages investors to consider the fund manager’s strategy, the quality of returns and the consistency of performance over the long term.

Below are excerpts from the interview.

Q: We are talking at a time when we are seeing a lot of volatility in the markets. There are also global headwinds. So, at this time, it is very important to understand what not to do as well. Let’s start with the basics. What are some of the most basic mistakes that an investor makes when investing in mutual funds?

Jain: Mutual funds as a vehicle, instrument or category have enabled many Indians to invest in the equity markets and ultimately be a part of India’s growth story. And while I think the momentum around mutual funds is increasing, I think there are certain misconceptions that we often see. I think the first and foremost one is that the core philosophy of building wealth or growing it over a long period of time is to use asset allocation, where asset allocation means diversification across three broad categories – equity, fixed income or debt, or gold. I think that is the best way to diversify your portfolio. It is also an automatic way to reduce risk in your portfolio.

There is a popular saying that in rising markets, one generally becomes blind to risk, and in falling markets, one becomes blind to opportunity. And I think that by using asset allocation, you avoid all that and you can do the opposite. I think that is something that every mutual fund investor should follow.

The second mistake is that we see a lot of mutual fund investors having a large number of schemes. I would say that over diversification or having too many schemes or mutual funds in the portfolio can be very ineffective because the ability to monitor them becomes very difficult, very challenging and that is where the portfolio becomes inefficient.

Thirdly, I would say that it is not a mistake, but I would say that we always recommend that when you invest in mutual funds, you should have a goal and an objective. If you don’t have one, you can still start, but having a goal will always allow you to plan your cash flows, how much money you should invest if you have a goal and an objective, and then you can work based on that.

Fourthly, I repeat that this is not a mistake, but what we are insisting on is that if you don’t understand it yourself, I think it will always be better to take advice from someone who can help you in choosing mutual funds and schemes. The other important part is to follow up and review periodically. So these are four things that I think can be common mistakes or something that people should pay attention to.

Q: The next question is the usual understanding of mutual funds: that they track the performance of an underlying asset, be it equity, debt, gold or a combination of the two. You have said that asset allocation is important, but do you think that understanding it is enough and that there is no need to go beyond that?

Jain: I would say yes, it is important to track the underlying asset because when you are investing in something, it is important and critical to have a benchmark to compare it with. It is always good to have a benchmark to compare it with, but it is not the case in the complete sense. I would say that the fund manager, his skills, the practices or the process used by the fund management team are also very important and critical when it comes to analysing the performance of the mutual fund.

I would say that consistency and quality of returns are very critical and important and simply following the underlying value might not be the only thing.

Q: Sometimes what happens is that when someone looks at mutual funds, the first thing they look at is past performance. What has the fund done in the past? But is that enough to decide whether to invest in a mutual fund or not?

Jain: When you invest in a mutual fund you have to look into the future because whenever you invest you have to look into the future and you have to look at the thesis of the fund manager, his strategy, his thinking, his thought process about it.

But looking at past performance is also very important because there has to be some reference point, some thought process, thinking about how to evaluate something and in that sense past performance is an important parameter to consider.

So when you look at past performance, you want to look at funds that are consistent and quality. So one of the issues is that there are a lot of people who invest looking at 12-month returns. I would say that you need to look not only at 12-month returns, but also at 3- and 5-year horizons.

Another thing is that you should also look at a mutual fund that has outperformed the benchmark or has been in the top quartile for a large part of its quarter. That is where consistency also comes into play. So, if you look at past performance, you should not get biased by looking only at short-term performance. Keeping the long-term performance in context will be important and critical as well.

Watch the attached video for the full conversation.