FINANCE SPECIAL ...DON’T MAKE THESE INVESTING MISTAKES

DON’T MAKE THESE INVESTING MISTAKES

The biggest investing mistakes happen when markets are doing well. We look at the possible errors that small investors are likely to make now.

Rohit Verma is more surprised than worried when he looks at his mutual fund statement. “The markets have gone up by almost 20% in the past one year but my mutual funds are showing losses,” says the Delhi-based bank executive. Verma had started two SIPs of ₹10,000 each in a large-cap and a mid-cap fund in July 2017. While the large-cap fund has earned marginal returns, the mid-cap scheme has lost money, forcing Verma to rethink his decision to invest.

A lot of small investors who started SIPs about 12-18 months ago are in the same boat. While their funds did very well initially, the performance has not been very encouraging in the past six months. In many cases, especially mid-cap and small-cap funds, the SIP returns are in the red. Large-cap funds have managed to stay above water, but only marginally. Most of the top performers in the category are passively managed index funds (see graphic).

The actively managed large-cap funds have underperformed the benchmark indices by a wide margin. The benchmark Nifty 50 TRI index has clocked around 19% returns over the past one year. Out of the 30-odd actively managed large-cap schemes, only two—Axis Bluechip and Edelweiss Large Cap—have managed to beat the index during this period.

MISTAKE # 1

Shift from diversified funds to index funds

The relative underperformance of actively managed funds is due to the high degree of polarisation in stocks forming the largecap universe. In the past few months, only a handful of stocks led by Reliance Industries, HDFC Bank, TCS and ITC have delivered outsized return. But since actively managed large-cap funds have more diversified portfolios and invest in stocks outside the index as well, the rise in these index heavyweights has pushed up index funds. “When only a small number of stocks skew the index return, most active funds will struggle to outperform the index,” explains Vidya Bala, Head of Mutual Fund Research, FundsIndia.

The divergence in the performance has made many investors like Verma question their decision to go for actively managed funds. If low-cost index funds are outperforming, shouldn’t they shift out of actively managed funds and avoid paying the higher fund management charges? No, say experts. “The Indian market is still not at a stage where index funds will consistently beat active funds. A well-constructed portfolio of funds using the new clearly defined mutual fund categories can continue to outperform the indices for the next few years at least,” says Sanjiv Singhal, Founder and COO of Scripbox.

MISTAKE # 2

Stopping SIPs because funds are down

Mid- and small-cap stocks have taken a severe beating in the past few months, resulting in losses for funds that had lined their portfolios with stocks from these segments. Jittery investors, who started SIPs in these funds within the last year and are now staring at losses, may want to discontinue their investments. Experts say this would be unwise. This is precisely the time when SIP investors will be able to make the most of the volatility by effectively fetching more units at lower prices for the same amount.

“You need to give a few years to any fund. If you are investing for 10 years and are in the right funds, then invest as much as possible,” says Vipin Khandelwal, Founder of Unovest. When the mid-cap segment regains strength, investors who persisted with their SIPs will stand to benefit. Over a period of time, SIPs will average out your cost and generate inflation beating returns. This is the simple key to building wealth.

For mutual fund investors, regular investing is a better strategy than timing the market. An investor who continues his SIPs irrespective of market movements is likely to make more money than one who lets market sentiments affect his decisions. For instance, if a mutual fund investor had stopped his SIPs or withdrawn his investments after this year’s Budget announced the LTCG tax on equities, he would not have gained from the rise in the market in the past six months.

MISTAKE # 3

Shifting from debt funds to fixed deposits

Interest rates are rising again after a gap of four years. The yield of the benchmark 10-year government bond is close to 8%, which has depressed the returns of debt funds, especially longterm bond funds. Other categories of debt funds have delivered barely 3-4% in the past year (see graphic). On the other hand, banks have raised their deposit rates. Many are offering 7-7.5% interest for 1-3 year deposits. Senior citizens above 60 will get 0.25-0.5% more. Given the high rates offered, investors might find bank fixed deposits and recurring deposits more attractive. They may be tempted to dump their bond funds in favour of bank deposits.

Experts are not sure. “Shifting from debt funds to fixed deposits will not be beneficial for investors. While bank deposits give assured returns, they are not tax efficient,” says Rohit Shah, Founder & CEO, Getting You Rich. The entire interest earned from bank deposits is included in the individual’s income for the year and taxed at the applicable slab rate. The post-tax return will be much lower for those in the higher tax brackets. Instead, investors should park some money in short-term or low duration debt funds and fixed maturity plans now. Bond funds are far more tax-efficient. If held for more than three years, the gains are treated as long-term capital gains and taxed at 20% along with indexation benefit.

However, the situation may be different for senior citizens. This year’s Budget has given senior citizens an exemption of up to ₹50,000 for interest income. For this segment of investors, it makes sense to shift some money out of debt funds to fixed deposits and earn tax-free income.

Besides the favourable tax treatment, bond funds may be poised to give better returns in the coming months. ET Wealth looked at the average one-year returns from long-term gilt funds when bond yields are at various levels. We found that when the 10-year bond yield is between 7.5% and 8% (as it is now), the one year forward return from gilt funds has been 7.32%. In other words, the worst may be over for the bond market.

MISTAKE # 4

Starting equity SIPs for short-term goals

Given the healthy return from some mutual funds over the past 2-3 years, some may be tempted to start fresh SIPs in equity funds. Some may even consider initiating a SIP in mid-cap funds to gain from the volatility. This is fine so long as you are not investing in these funds for short-term goals or hunting for quick gains. Given that valuations in select pockets from both segments are still stretched relative to historical levels, returns are likely to be muted in the near term, feel analysts. Investors coming in with a short-term horizon (less than three years) now may be left with a sour taste in the mouth. Experts says investors should commit to at least a five-year horizon to benefit from the SIP. “At a fundamental level, the fund must align with your risk profile and time horizon. If you need the money in three years, you shouldn’t be in equity funds,” warns Khandelwal.

MISTAKE # 5

Investing in mutual funds for dividend

Some mutual fund houses have pushed their equity-oriented funds as a source of regular dividend income for investors. Gullible investors did not realise that dividend from a mutual fund is only their own money coming back. “Dividend is the opium of the investors. For too long, it has been used as a bait to lure in investors,” says Khandelwal.

But this bait now comes with a tax tag. With 10% tax on dividends introduced now, the proposition is no longer taxefficient. Investors who are still tempted by the consistent dividend payouts from these schemes should reconsider their decision. Also, dividends are paid out of the distributable surplus accumulated by funds over the years; there is no guarantee that they will be able to sustain the quantum of payout. If the market nosedives, these funds may not have enough surplus left and dividend payouts may get increasingly erratic. “Entering an equity oriented investment for the sole purpose of income generation is a bad idea,” insists Amol Joshi, Founder, PlanRupee Investment Services.

MISTAKE # 6

Turning too bullish on stocks

The rally has filled investors with confidence. But overconfidence is a dangerous feeling in the stock market. Investors who are less confident tend to make fewer mistakes than those who are brash and carefree. If you have made good money in the stock market, it’s time to rebalance the portfolio and restore the initial asset allocation. Yet, a lot of investors tend to become their own worst enemies and turn to panic buying. Behavioural scientists say that human biology plays its own tricks here. When a trade goes right and you make money, the brain releases dopamine in the body, which makes the individual feel positive and more confident of doing well. Dopamine is also addictive and makes people feel positive, confident, and energetic. The bigger the anticipated rewards, the more dopamine is released by the brain, pushing the investor into a vicious cycle.

Experts say asset allocation holds the key to wealth creation and should be followed like a religion. “The best way to protect your portfolio is by deciding on a percentage balance between equity and debt, and sticking to it by periodically shifting money away from the one that becomes high to the one that becomes low,” says Dhirendra Kumar, CEO of Value Research (see guest column). A prudent investor will overcome emotional biases and rebalance his portfolio to reduce the risk.

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