I have been investing in SIPs for over a decade now and have made a fair share of mistakes. This article is a comprehensive assessment and assortment of these errors. What I could have done better and the learnings from my mutual fund mistakes that can help you make better risk-adjusted returns
The difference between above average returns and below benchmark returns is not really which fund or scheme one chooses. It is the subtle maintenance-type strategies that need to be done or planned for that often make the difference.
I have been investing via mutual fund SIPs for over a decade now. Some avoidable investing mistakes I have made are –
- Choosing the wrong mutual fund type
- Opting for a regular mutual fund over a direct mutual fund
- Selecting a mutual fund scheme without researching it thoroughly
- Over-reliance on any one type of sector or too much diversification
- Only looking at historical mutual fund scheme returns and having unrealistic goals
- Choosing dividend over growth
- Not boosting my SIP amount
Recommended Reading: I have written a comprehensive post on using Index Funds to build a high return-low risk wealth corpus. The article explains how one can use an asset allocation + annual rebalancing + SIP strategy. It is supported with an internal study over a 14 year period and codifies how to make an additional 1.7% annual returns.
Here are the mistakes I made.
Choosing the wrong mutual fund type
A good mutual fund is one that –
- Is based on your risk profile. If you have never looked beyond bank fixed deposits, then please dont invest in an “alternative assets” SIP. It is a most unsuitable decision for you as they are highly risky
- Factors your need for money or liquidity. An equity fund growth plan is not suitable to senior citizens who want to extract money on a monthly basis for expenses
- In coherence with the investment tenure or goals. If you need ₹1 lac in 10 months for your child’s college admission, investing ₹10,000 in an equity SIP should be avoided. I won’t even recommend investment in debt funds with liquid funds or money market funds or arbitrage funds being a safer alternative.
If you are not sure what to do, I highly recommend you avail the services of a financial planner. The advisor can draw a proper plan for you.
A useful tip here.
Go for financial planners who give you options and don’t force you to buy a particular fund or financial product. And please ensure that you pay the financial planner for their services via fees. Afterall, the advice they are giving is helping you make more money and reduce your mistakes.
Opting for a regular mutual fund over a direct mutual fund
If you enroll to a mutual fund SIP from your bank or agent, there is a high chance that the mutual fund you are offered will be a regular mutual fund and not a direct mutual fund.
A regular mutual fund is one where the distributor commissions are in-built while there are no distributor commissions in a direct plan.
Do read my article on the difference between direct mutual funds and regular mutual funds, for a better understanding
How to identify if the mutual fund scheme offered to you is a regular or a direct plan?
Generally, fund names will not have the word regular written on them. However, if the scheme is a direct fund, the name will clearly have the word “Direct” written on it.
Please examine the names below.
These are six large cap schemes. However you’ll see that the names of three sets have almost no difference except for the word “direct”. The schemes where Direct is written are the direct plans. And the ones where nothing is written are the regular plans.
Opt for direct when looking at a long-term buy
While opting a long-term SIP, it is highly recommended to opt for a direct plan and avoid a regular plan.
In another article, we saw the importance of opting for a regular plan which will turn into a loss of wealth of ₹69,48,854.
We came up with this number with a scenario where you invest ₹10,000 every month for the next 30 years in an SIP which is giving you a return of 12.00% in regular plans and 12.80% in direct plans.
Here is how the difference will play out –
SIP on Regular Mutual Fund (12.00% annual returns)
- Total Amount Investment = ₹36,00,000 (i.e. ₹10,000 * 12 months * 30 years)
- Total Wealth Generated = ₹3,52,99,138
SIP on Direct Mutual Fund (12.80% annual returns)
- Total Amount Investment = ₹36,00,000 (i.e. ₹10,000 * 12 months * 30 years)
- Total Wealth Generated = ₹4,22,47,992
This ₹69,00,000 (i.e. ₹4.22 crores minus ₹3.52 crores) you lost has made its way into your financial advisor’s pocket in the form of commissions.
Imagine paying your financial advisor ₹69 lacs in fees just for helping you choose a fund and doing the paperwork.
I highly recommend direct plans when opting for mutual fund SIPs.
Selecting a mutual fund without researching it thoroughly
You will be surprised how many people are guilty of investing without understanding what they are getting into.
I recently read a newspaper article where the author conducted research experiments on the speed of decisioning. He concluded that Indians chose which mutual fund or stock to purchase faster than the time it takes them to choose what food to have at a restaurant.
Most beginners follow a very thumb-rule based strategy. This generally revolves around two factors –
- the 1-year returns and
- the number of stars (which is the score or rank given by firms which track mutual funds).
In my opinion, both these factors form an incorrect or insufficient basis to selecting a fund.
Let’s assume you have done your due diligence. Now let’s figured you need to start an SIP in a large cap fund this month. Here is what you have to do as part of your research.
1) Identify a mutual fund screen website
Identify a website that can give you a list of all large cap funds with the necessary details. I use valueresearchonline.com and the listing of large cap funds can be found on there (click on the link)
2) Enroll into SIPs of only Direct mutual funds
We agreed that all SIP will be done only on direct funds, so make sure that you exclude regular funds in the top panel. And click on the “Update Funds” button.
3) Examine the performance of mutual funds
c) You should now examine the returns offered by the available funds. For this, click on the RETURNS button and sort the funds in descending order
This gives us our first shortlist which includes –
- JM Core 11 Fund – Direct Plan
- Nippon India Large Cap Fund – Direct Plan
- SBI Bluechip Fund – Direct Plan
- ICICI Prudential Nifty Next 50 Index Fund – Direct Plan
- IDBI Nifty Junior Index Fund – Direct Plan
I have taken five schemes here for purposes of illustration but you can extend it upto 10 schemes.
What is interesting here is that the 1 year returns of these five shortlisted funds have vacillated from -0.60% to 15.46%. There is a reason behind this which I will discuss later in this section, but for now kindly ignore the 1 year return.
4) Sort by AUM of funds
d) Now we need to understand the AUM (or assets under management) that each of these schemes manage. To know this number, click on SNAPSHOT and see the values under the column Net Assets (crs).
The net assets or AUM for our shortlist is as follows –
- JM Core 11 Fund – Direct Plan (₹37 crores)
- Nippon India Large Cap Fund – Direct Plan (₹11,694 crores)
- SBI Bluechip Fund – Direct Plan (₹20,395 crores)
- ICICI Prudential Nifty Next 50 Index Fund – Direct Plan (₹380 crores)
- IDBI Nifty Junior Index Fund – Direct Plan (₹48 crores)
We see that some funds are mega funds with over ₹10,000 crores under management while some others have much less to manage. It has generally been observed that funds which have too high AUM find it difficult to generate alpha returns. Alpha means incremental returns over the benchmark. So my recommendation is to give preference to funds which are less than ₹10,000 crores in AUM.
I have not found any similar handicaps in case a fund as a low AUM however it is always better to look for funds which have atleast ₹400 crores under management. These funds will have a lower expense structure as compared to funds which are just ₹100 crores or lower in size.
For the purposes of this study, we are not excluding any of our shortlisted funds on the basis of AUM size.
5) Understand the funds in depth
At this point, it is important to examine each of these funds more closely.
ICICI Prudential Nifty Next 50 Index Fund and the IDBI Nifty Junior Index Fund
Both these are index funds i.e. they perform in line with the benchmark that they are tracking.
The ICICI Prudential Nifty Next 50 Index Fund and the IDBI Nifty Junior Index Fund both track the NIFTY Next 50 TRI. This index consists of companies which rank between 51 and 100 as per market capitalization in the stock markets.
So, technically these are not exclusively large cap funds as you will not find companies like Reliance Industries, TCS, Infosys, HDFC Bank, State Bank of India, HDFC etc. in these funds.
To see the portfolio of these funds, you can go to the mutual fund website or click on the PORTFOLIO tab in the Value Research Online link shared earlier.
This defeats your purpose of selecting these as your large cap mutual fund SIP as they aren’t really large cap. And because of the restriction that they need to follow the NIFTY Next 50 TRI, the fund will miss out on investing in giant capitalization companies. You will have to leave these two funds out of your consideration for now.
JM Core 11 Fund
The JM Core 11 Fund follows a strategy of having a concentrated portfolio of not more than 11 company stocks. And where every stock is invested to the extent of 9.09% of the NAV of the scheme. The fund has no market capitalization or sector restrictions.
The last line related to no market cap restriction is very important. That’s because this fund too does not fit with our original strategy of setting up an SIP in a large cap fund. As a result, we have to exclude this fund from our discussions.
Nippon India Large Cap Fund
The fund philosophy of Nippon India Large Cap Fund supports the kind of fund we are looking for.
This fund predominantly invests in stocks of the top 100 companies by full market capitalization. The fund aims to provide stability & liquidity to the portfolio as it invests in –
- market leaders with established business & operating models
- proven management track record and
- ability to generate high cash flows.
We can take this fund into consideration
SBI Bluechip Fund
The SBI Bluechip Fund is also a large cap stock. This fund aims to provide investors with long-term growth in capital by investing in a diversified basket of large cap equity stocks. These are companies which are ranked 1st to 100th company in terms of full market capitalization. The fund’s investing strategy follows a blend of growth and value style on investing.
Like Nippon India Large Cap, we can take SBI Bluechip Fund also into consideration.
6) UNDERSTAND THE RISK AND STATISTICAL MEASURES OF EACH MUTUAL FUND
The final check will be done using some risk statistical measures which are readily available. Unfortunately, most people don’t understand these number but here we’ll make an effort to examine these. We’ll also see how to use these as as part of our decisioning process.
All statistics are not equally important. As part of this decisioning process, we will only emphasise on the ones that really make sense.
1. Sharpe Ratio
Sharpe Ratio measures how well the fund has performed when compared with the risk taken by it. The higher the Sharpe Ratio, the better the fund has performed in proportion to the risk taken by it.
Sortino ratio measure the performance of the fund relative to the downward deviation. I find this a more appropriate measure as compared to standard deviation which factors downward and upward risk. But as investors are only concerned with downside risk, Sortino offers a more realistic picture of a funds performance to an investor. Larger the Sortino, lower is the probability of a large loss.
Ignore Beta and Standard Deviation
The statistics I choose to ignore –
- Beta – Beta measures a fund’s volatility relative to its benchmark. In other words, it depicts how much the fund will swing if the benchmark moves a point. E.g. a Beta of 2 says that if the benchmark moves up by 1%, then the fund will move up by 2%. I don’t use Beta because the benchmark can move either ways (up or down). And since, as an investor, I love upward movement and detest downward movement, the Beta does not help me much with decisioning
- Standard Deviation – Standard deviation measures the volatility a fund’s returns in relation to its own average. The higher the number, the more volatile is the fund’s returns. Again, when the fund is moving up, I would appreciate the upward volatility and vice-versa. This is the reason why I keep it outside my decisioning.
Let’s look at the Sharpe Ratio and Sortino of the two funds in question.
The Sharpe ratio of the Nippon India Large Cap Fund is 0.90 which is higher than the Sharpe ratio of the SBI Bluechip Fund which is at 0.60. This means the Nippon India Large Cap Fund has a more favourable return-risk equation as compared to the SBI Bluechip Fund.
Further, the Sortino of the Nippon India Large Cap Fund is better at 1.46 as compared to the 0.90 of the SBI Bluechip Fund. This means the Nippon India Large Cap Fund has better capability in avoiding a large loss as compared to the SBI Bluechip Fund.
On the basis of this assessment, I will start my SIP on the Nippon India Large Cap Fund.
To conclude, we looked at a simple process where we identified the key areas that we need to see before selecting the type of fund that sits best with our SIP objectives. We looked at –
- Type of plan (direct & regular),
- AUM size,
- What consists of the fund (index v/s select stocks) and
- Statistical measures to judge fund performance
Over-reliance on any one type of sector or too much diversification
In other words, you are either putting all your eggs in one basket or creating too many baskets. Modern studies have found that both approaches are detrimental to your objective of achieving high alpha on your investments.
Portfolio skewness to a particular sector
It might surprise you that your portfolio can be loaded around a single sector without you having much knowledge of it. This is particularly seen when you have a high percentage of large cap mutual funds in your portfolio.
Generally, large cap funds which operate on a growth mindset have a high percentage of financial sector stocks which ranges from 30-40% of the assets managed by the scheme.
As it stands (on 31st March 2019), index mutual funds which track Nifty 50 have the following % of their assets per sector –
- Financial – 37.4%
- Energy – 16.4%
- Technology – 14.9%
- FMCG – 8.3%
- Automobile – 6.6%
- Construction – 5.3%
- Metals – 2.9%
- Healthcare – 2.5%
- Chemicals – 2.2%
- Communication – 1.5%
- Services – 1.2%
- Consumer Durables – 1%
A second bias (mistake). It is observed especially with beginner investors that they over-rely on returns in making a fund decision. This always leads to an ill-devised approach to portfolio management and skewed sector approach.
An expensive lesson learnt by beginner investors
A new & fast growing investing app offered over 1,000 mutual fund schemes to its users. This was done in a single page listing where it sorted the schemes in a descending order by 1-year returns.
The fund which came on top was the Tata Digital India Fund. This fund, at that time, was showing a 45% return over a one year period. And amateur investors lapped up this fund.
Since then, the return on this fund has slightly dipped and the 1-year return is now about 23%. However, if the investing app had done a more rational exercise and featured the equity scheme with a 3-year then the annual returns would be a more sane 13%.
As a result of this 45% return carrot, a number of investors went for this fund only to find that their investments are down by 14% over the next 4 months. This is because they didn’t follow a proper criteria to evaluating mutual funds and selecting the correct fund for their SIPs.
Too much diversification
I too was guilty of this and still find myself making this mistake when I do my bi-annual portfolio rebalancing. Too much diversification occurs when you start buying too many funds which somewhat retain the same type of stock-picking strategy.
As a result, while you have a number of actively managed funds, the overall shape of your portfolio simply ends up mimicking all the stocks that are there in the stock market.
If the idea of our portfolio is to have all the stocks in the stock markets then we are better off going in for index funds rather than actively managed funds. Index funds are much lower in expenses and have the ability to offer on-par or superior returns to actively managed funds in the moderate to long run.
Only looking at historical performance & having unrealistic goals
If you expect your mutual fund SIP to deliver 50% returns in an year, you might have set for yourself a rather unrealistic goal.
I use the word “might” because there have been years where the stock markets have performed exceedingly well. But then, will you be ready to expect a loss of 20% in the year after that phenomenal jump? If the answer is no, then you have bolted yourself into thinking that you can make a phenomenal return on your equity investments every year that really does not happen.
Let’s see how the Indian equities have delivered in annual returns over the past 20 years.
1998 : -18.1%
1999 : 67.4%
2000 : -14.70%
2001 : -16.20%
2002 : 3.30%
2003 : 71.90%
2004 : 10.70%
2005 : 36.30%
2006 : 39.80%
2007 : 54.80%
2008 : -51.80%
2009 : 75.80%
2010 : 17.90%
2011 : -24.60%
2012 : 27.70%
2013 : 6.80%
2014 : 31.40%
2015 : -4.10%
2016 : 3.00%
2017 : 28.60%
2018 : 3.20%
In the past 20 years, there have been 14 years of positive returns and 6 years of negative returns.
Let’s see how an investment made in 1998 would have performed.
If you had invested ₹10,000 on 1-Jan-1998, you would have received your first jolt by the end of the year. That’s when the ₹10,000 would have reduced to ₹8,190 giving you a capital loss of 18.1%. If you had the temerity to continue, then 1999 would have been a bumper year when the stock markets grew by 67.4%, converting that ₹8,190 to ₹13,710.
Net net, the growth of your ₹10,000 to ₹13,710 over two years gives you a CAGR of 17.1%
This is followed by two years of downturn (2000 and 2001) due to the dot-com bubble bursting with negative stock market years of -14.7% and -16.20%. By the end of this fourth year, your capital has depreciated by 0.5%. So ₹10,000 is now almost at par i.e. ₹9,950.
After a rather heady start, your money saw the boom years (twice) of 2003-2007 and 2012-2017. In this period, it delivered 10 (out of 11) years of positive returns. A couple of setbacks came on the way with 2008 and 2011 which tested your resolve but you decided to stay put.
At the end of your 20 year journey (in 2018), your capital of ₹10,000 would have grown to ₹1,00,558
That’s a growth of 10X!
Understanding CAGR on investment in different years
From a CAGR perspective, you grew your money by 11.6% per annum. See table below on how your CAGR changed from year-to-year.
Now, you might argue that 1998 to 2002 were genuine bad luck and you saw it coming. Your crystal ball predicted that 2003 will be the start of great times. And you made the investment of ₹10,000 on 1-Jan-2003 thereby starting your first year with an awesome 71.9% appreciation in your capital. You expect the next 15 years to be absolutely rocking.
And to your surprise, you see that your ₹10,000 in 2003 has increased to ₹99,330 giving you a CAGR of 15.4%. This came in a period when had only 3 negative growth periods.
This exercise helps us set the expectations right.
- Think long term as the returns in the short-run can vacillate from -51% to +71%
- When thinking long-term, base your assumptions around 12%. Don’t go for some random 50% annual return just because this was achieved in some solitary year. Actually a 50%+ stock market return was achieved in 4 years over the past two decades
Net net, here is my recommendation with regards to your expectations from mutual funds over the long-term (from now to the next 20 years) –
- Large cap mutual funds : 12%
- Diversified mutual funds : 14%
- Mid & Small cap mutual funds : 14%
- Debt funds : 8%
Choose dividend over growth
Many investors choose the dividend option over the growth option when investing in mutual funds via the SIP route. In other words, the appreciation that the asset gain is withdrawn by the investor in the form of dividend.
This is anti-compounding because the investor is not allowing the appreciated part of the capital to appreciate more and earn you more wealth.
Now it is understandable that some users want regular income in the form of dividends. But, for regular income, I don’t recommend equity mutual funds to be the correct vehicle for that. You will be better off investing via debt or hybrid funds if you are looking for dividend.
A further tip here.
If you need monthly income from your investments, have a preference for the growth option as compared to the dividend option. You can setup a systematic withdrawal plan which allows you to redeem a specific amount from your investment corpus. This is better than a dividend plan because the dividend is entirely subject to the mutual fund company releasing it. This dividend may not be released in a particular month or it might be less than the normal.
An Example: Sundaram Small Cap Fund
Let’s check out the dividend option of one such fund – Sundaram Small Cap Fund (Dividend Plan).
The Sundaram Small Cap Fund has been consistently offering dividends on a quarterly basis.
The table below sheds lights on some truth –
1. The amount of dividend has not been consistent and depends on the performance of the fund.
The fund has distributed values such as ₹1.0000, ₹0.5000, ₹1.5000, ₹0.4427 and most recently ₹0.3099 as dividend to its investors
The recent dip in dividend is in line with the correction in small cap funds. The dip have significantly reduced the NAV of the fund from an average of ₹24.0000 in 2017 to a more depleted ₹17.3014 at the time of writing of this blog post.
As an investor you cannot be certain how much dividend shall be released. There is 80% difference between being paid ₹1.5000 per unit versus ₹0.3099 per unit. Imagine getting only 20% of the income to manage your monthly expenses. Not a good situation to be in!
2. While Sundaram Small Cap Fund has ensured release of some dividend on a quarterly basis, there are quite a number of funds who do not post dividends when the fund value has diminished beyond a certain point.
The reason for this reticence on the part of the mutual fund company has to do with how they are structured from a compensation standpoint.
Mutual fund companies make money from the AUM they possess i.e. how much money they have from investors to manage.
India’s largest mutual fund company by AUM as on date is HDFC Mutual Fund with ₹3,34,964 crores as on 31st December 2018. A more recent data by AMFI puts the AUM figure of the total mutual fund industry at ₹23,16,403 crores. The AUM in Feb 2009 (exactly 10 years ago) was ₹5,09,000 crores.
The assets under management have grown by over 450% in the last 10 years!
Coming back to the compensation structure, mutual fund company revenue is a percentage of the AUM they keep. Generally, mutual fund companies make about 1.5% per year of the funds they have in equity instruments and about 0.6% per year from the debt instrument mutual funds. So, it is not in their interest to allow outflow of funds whether it is through redemption, switches (transfer-outs) from equity funds or dividends.
Now, Sundaram Mutual Fund cut in dividend per unit is more likely to have the nefarious purpose of preserving it’s AUM.
The fund house seemed to have figured out the marketing ploy. Seems they can always play on the dividend yield which is still around the 2% (of NAV) mark. This gives something to the distributors to pitch to their clients. However from an investor’s perspective it really doesn’t give a stable income.
Not boosting your mutual fund SIP amount
People start with a very clean strategy of dedicating x% of their income to growing their wealth. For illustration sake, people start by parking 10% of their income into mutual fund SIP instruments.
The problem starts after 2-3 years when their income has grown by a good 30-35%. However they haven’t increased their saving via SIPs in the same proportion.
I often see these investors investing a lumpsum in real estate after they have accumulated excess capital in savings bank accounts and fixed deposits. What they should have been doing is investing as and when there is some additional earnings in equity SIPs. Here’s why?
Scenario 1 –
- Monthly investment in SIP = ₹1,000
- Number of years = 20
- Expected CAGR = 12%
- Increase in investment in SIP each year = 0%
Scenario 2 –
- Monthly investment in SIP = ₹1,000
- Number of years = 20
- Expected CAGR = 12%
- Increase in investment in SIP each year = 10%
Now, you won’t do too bad in Scenario 1 because you would have accumulated a respectable ₹9,99,148 in wealth over these 20 years.
However, we should never ignore the value of that little extra 10% that you were able to add to your SIP investment which was in tune with your increase in income.
Per Scenario 2, your investment over 20 years would have aggregated to a healthy ₹19,88,872. That’s 2X of the wealth generated by employing Scenario 1.
The lesson here is that you must boost your SIP as often as you can so that you can build more wealth by taking advantage of compounding.
Additional Resources You Might Like
Here are some articles you might like:
- Rakesh Jhunjhunwala and his secrets to investing (Part 1)
- Complete SIP Investment Guide (over 8000 words compedium updated until 2020)
- The trillion dollar index fund story that John Bogle started in the 1970s
- Best SIP for achieving long term goals
- 5 steps on choosing the right term insurance plan for yourself