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Four Habits That Can Damage Your Mutual Fund Portfolio
While mutual fund investing is relatively simple in principle, there are in fact a few all too common mistakes that can wreak havoc on your portfolio and negate your chances of making good returns from them. Be careful to not make these mistakes.
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Mutual Funds have been designed to make investing simple. The efforts involved in conducting rigorous research, predicting future economic trends and selecting stocks are effectively delegated by Mutual Fund investors to the Fund Management team of the asset management company. While mutual fund investing is relatively simple in principle, there are in fact a few all too common mistakes that can wreak havoc on your portfolio and negate your chances of making good returns from them. Be careful to not make these mistakes.
Not following an Asset Allocation strategy
However high or low the stock markets are headed, going all out into equity funds isn’t a good idea. Neither is being steadfastly risk averse and allocating all your money to debt funds! Instead, take a risk profiling quiz and determine your ideal asset allocation (percentage of equity and percentage of debt) based on your unique situation.
Your ideal asset allocation may vary depending upon the state of the stock markets too. For instance, if markets are deeply undervalued, even low risk investors may want to have at least 30% of their assets in Equity Funds. What’s important is to have a well thought out, rational asset allocation plan – and sticking to it.
Churn & Burn
By and large, your mutual fund portfolio is meant to be relatively passive. You do not necessarily need to churn your portfolio every couple of months and replace your existing funds with different funds, or especially NFO’s (New Fund Offers) which may have higher expense ratios and no previous track records of performance. If your advisor is recommending frequent churns, this probably isn’t in your interest.
Remember that your Fund Manager is, in fact, managing your portfolio dynamically and using his research workforce and intellect to have you in the best possible stocks at any given point of time. Attempting to ‘manage the manager’ will create very little value addition, if any. It could also create tax inefficiencies and lead to losses in your portfolio, if you’re unlucky.
Not reviewing it periodically
The converse of the ‘churn and burn’ trap is the super-passive approach of not rebalancing your portfolio at all. Remember that market movements will distort your ideal asset allocation, and it’s a wise idea to go back to your portfolio once a year and check whether you’re not skewed in either direction. You could do this on your portfolio anniversary, once a year on a specific date, or depending upon market triggers (such as when the Nifty PE Ratio dips below or crosses a certain level).
Being too passive may lead to an accumulation of ‘has been’ funds in your portfolio. Many funds perform well for a time, and then they either become unwieldy or a systemic change in the asset manager leads to extended bouts of underperformance. It’s important to go back to your portfolio with the support of a qualified Advisor, and weed out these underperformers.
Having a Scattered Portfolio
There are no medals for owning tens of mutual funds; only to eventually lose track of them as monitoring them just became too tedious.
A single Equity Mutual Fund scheme is likely to be investing into 50-75 different stocks, so there’s really no point in owning several funds.
In fact, studies have shown that diversification benefits taper off beyond a point and start affecting your portfolio negatively after a point. It’s better to draw the line at 5 to 7 funds in each category (equity and debt) at all points of time. If you have a very large portfolio, you may want to extend this number to a ceiling limit of ten funds in each category, but going beyond that will just work to your detriment.