Friday, 22 February 2013

10 Secrets of Mutual Fund Investing


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What do you think – is investment a problem or solution? Who does your investment make rich – your or the middleman i.e. the mutual fund, broker, distributor, rating agency, company promoter etc? How do you select a MF scheme – on your knowledge, experience or judgment or based on some recommendation or tip by a so called fund expert or market guru? Have you ever lost money in absolute terms i.e. entire or a part of your capital? Have you ever lost money in relative terms i.e. your investments earning positive returns but much less than the other alternative investments? Have you been able to differentiate between good and bad mutual fund schemes? Do you know the true clandestine of long term wealth creation? If not, then read on to unlock the true secrets of mutual fund investing.

Avoid the herd mentality

The typical mutual fund investors buy decision is usually heavily influenced by the actions of his acquaintances, neighbours or relatives. Thus, if everybody around is investing in a particular fund, the tendency for potential investors is to do the same. But this strategy is bound to backfire in the long term. No need to say that you should always avoid having the herd mentality if you don't want to lose your hard-earned money in the markets. And this rule applies to a mutual fund investor as well as a fund manager. The world's greatest investor Warren Buffett was surely not wrong when he said, "Be fearful when others are greedy, and be greedy when others are fearful!"


Take informed decision

Proper research should always be undertaken before investing in funds. But that is rarely done. If you don't have time or temperament for studying the markets, you may even take the help of a financial advisor.


Invest in business you understand

Never invest in a fund which you don’t understand. Never buy a fund which has a low NAV but always invest in a fund which has a good underlying portfolio of stocks, bonds or whatever the case which may be. And invest in the fund which you understand – equity, fixed income, money market, commodity, hybrid etc. Don’t invest in fancy fund names, sector or thematic funds – remember they are just fads by mutual fund managers and their distributors to loot the gullible investor of his hard earned money.
Understand, for instance, what your fund buys and sells, and how they make money. Thus, the more you understand the business of the company, the better you will be able to monitor your mutual fund investment.


Don't try to time the Fund

One thing that even Warren Buffett doesn't do is to try to time the stock market, although he does have a very strong view on the price levels appropriate to individual shares. A majority of investors, however, do just the opposite, something that financial planners have always been warning them to avoid, and thus lose their hard-earned money in the process. So, you should never try to time the market. In fact, nobody has ever done this successfully and consistently over multiple business or market cycles. Catching the tops and bottoms is a myth. It is so till today and will remain so in the future. In fact, in doing so, more people have lost far more money than people who have made money. And if you can’t time the market than it is a sine qua non that you would not be able to and never try to time your mutual fund investment.

Follow a disciplined investment approach

Historically, it has been witnessed that even great bull runs have shown bouts of panic moments. The volatility witnessed in the markets has inevitably made investors lose money despite in the great bull runs. Lot of investors, although successful in the short term, actually lose over the long term simply because they don’t follow a disciplined investment approach. However, the investors who put in money systematically, in the right shares and held on to their investments patiently have been seen generating outstanding returns. Hence, it is prudent to have patience and follow a disciplined investment approach besides keeping a long-term broad picture in mind. Remember that investment is a simple mechanical boring process.

Do not let emotions cloud your judgment

Many investors have been losing money in stock markets due to their inability to control emotions, particularly fear and greed. In a bull market, the lure of quick wealth is difficult to resist. Greed augments when investors hear stories of fabulous returns being made in the stock market in a short period of time. This leads them to speculate, invest in fancy mutual fund schemes of lesser known funds without really understanding the risk involved. Instead of creating wealth, these investors thus burn their fingers very badly the moment the sentiment in the market reverses. In a bear market, on the other hand, investors panic and sell their long held good mutual fund schemes at rock-bottom prices. Thus, fear and greed are the worst emotions to feel when investing, and it is better not to be guided by them.

Create a broad portfolio of funds

Almost 90% of portfolio variability is due to asset allocation while only 10% of the variability in portfolio performance is due to market timing and stock selection. The only thing in your control is asset allocation and the good news as written in lesson number 1 is that 90% of portfolio variability is due to asset allocation. Diversification of portfolio across asset classes and instruments is the key factor to earn optimum returns on investments with minimum risk. The reason for the relatively poor performance of portfolios of individual investors even in greatest of bull runs has been lots of variation in different schemes. There have been periods running into several months or years when the entire rally has been in equities or on other occasions by fixed income securities while sometimes by inflation hedges like gold. So, it becomes imperative to diversify your portfolio across various mutual fund schemes which provide you with such a diversification.

Have realistic expectations

There's nothing wrong with hoping for the 'best' from your mutual fund investments, but you could be heading for trouble if your financial goals are based on unrealistic assumptions. For instance, lots of equity funds have generated more than 50% returns during the great bull run of recent years or even debt fund returned in excess of 25% in times of substantial fall in interest rates. However, it doesn't mean that you should always expect the same kind of return from the markets. Have realistic expectations from your mutual fund investments – this in itself will ensure that you avoid a lot of common financial mistakes.

Invest only your surplus funds in high risk funds

If you want to take risk in by investing in high risk unknown funds, then see whether you have surplus funds which you can afford to lose. It is not necessary that you will lose money in them; your investments can give you huge gains too in the months to come. But no one can be hundred percent sure. That is why you will have to take risk. No need to say that invest only if you are flush with surplus funds.

Monitor rigorously

We are living in a global village. Any important event happening in any part of the world has an impact on our financial markets. Hence we need to constantly monitor our portfolio and keep affecting the desired changes in them. If you can't review your portfolio due to time constraint or lack of knowledge, then you should take the help of a good financial planner or someone who is capable of doing that. And while selecting a good broker or distributor don’t go after some high flying big name or market guru; instead opt for a person with common sense who considers himself as a student of investing.

Conclusion

To conclude, there are many simple and avoidable mistakes which we human beings as social animals succumb to at different levels of our dealing with money, be it at the time of earning, protecting, budgeting, saving, spending, leveraging, investing and insuring. 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. This article made a humble attempt to explain the 10 secrets of mutual fund investing.   

Before I end this article, 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 at the time of dealing with money – 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 mistakes which human beings commit while dealing with money and investing so as to embark on becoming your own a successful “money manager” and a complete human being.


39 comments:

  1. There has always been a little risk on doing investments on anything. We used to be a member of a social club and invested 13 thousand dollars but after the owner got flat-broke we never got our money back.

    Anyways. I read your blog post and you've have a good insight about it. So thanks for sharing and keep writing stuffs like that.

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  3. Whether you are a beginning investor or an expert, you'll only need to know a few basic things before buying mutual funds. Read More » ... Mutual Funds Spotlight10. How Much Gold and Apple Is In Your Mutual Fund. learn more 

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  5. Thanks Jackleen for your nice and encouraging comments.

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  6. Yes, we should understand first about a business and then we can invest in it. We should also invest in an existing business for better results.
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    1. Correct. We should invest properly so as to never become slaves of money.
      The world is moving forward technologically but we humans are moving backwards financially. We may have all modern facilities like online banking and investing, credit and debit cards, access to financial information, easy loan facilities but our financial knowledge is diminishing. Today, we see young educated people earning very good income but then not able to protect their money from financial predators, they pay everybody like the government, banks, electricity bills, telephone bills, children school fees etc but forget to pay themselves via surplus budget, don’t know when to cut spending and when to spend to get rich, have no protection in the form of financial insurance, are not aware of the difference between saving and investing, buy liabilities mistaking it to be assets with negative leverage which puts them in the web of unnecessary avoidable recurring expenses which then sadly makes them “slaves of money” for life – wage slave of the employer, tax slave of the government and loan slave of the bank.

      The only thing certain about money is that it is uncertain. We have to understand mysterious behaviour of money and its deepest secret rules. The poor work for a living, the middle class get into debt and keep working for money while the rich make their and other people’s money work for themselves. We have to learn on how to make our as well as other people’s money work for you. When we achieve financial independence, we can live a personal debt-free life, enjoy our retirement, spend without feeling guilty and leave our legacy. We have to learn to retire from our work as our money will start working for us. If you have to give one thing to your children then give them the gift of financial freedom. If you want to leave your name, wealth and legacy in this world then you need to know the “10 Commandments for Financial Freedom”.

      Money is the only thing which is available in abundant in the world today, it is available at the free will of the government and how fast their printing machines can function. You tell any government to give you unlimited amount of gold, silver, copper, steel, oil, sugar, wheat or any other real commodity, they will not be able to give you because Mother Earth has given those in limited quantity but you tell any government to give paper money and they can give you that in unlimited quantity - they just have to print it. We all human beings run after money little knowing that it is the only thing available in abundance in unlimited quantity. And if the government can print money, so can you do legally! That is what we have to aim to become from financial slavery to financial freedom.”

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