While a majority of the research houses, fund houses, consulting firms and other third-party brokers are busy promoting mutual funds, we thought to deviate from the regular lot and educate our readers on when they should avoid mutual funds.
This article aims to give you a crisp idea on when you should not invest in mutual funds and what could go wrong if the decisions are made wrongly.
1. Looking for short-term gains
We believe fundamental investors are well rewarded when they remain invested for long term. While mutual funds may witness short-term disruption, over the long-term it tends to outperform any asset class. Thus, an investor who is looking to invest for a very short-term period should ideally avoid.
2. Risk-averse investor
An investor who is risk-averse and cannot withstand capital loss should avoid mutual funds. Mutual funds are subject to market risk, however, if you remain invested over the long term you tend to benefit significantly. It is advisable that investors should remain invest for a period of 5-7 years across a business cycle in order to garner healthy returns.
3. A senior citizen who intends to get their monthly cash inflow
Markets are disruptive at times and thus it is not a wise idea to invest when your monthly cash flow is dependent on the amount you have invested. This approach becomes very risky as an investor may lose on his/her monthly inflow thereby resulting in cash flow mismatch.
4. Unplanned goal based investing
Goal-based investing is rapidly taking the centre stage in the mutual fund industry. However, if you are investing the money that is earmarked for say home loan EMI in order to get some quick bucks, it is not a wise decision. Given the fact that timing market is next to impossible, an investor may lose money if it is not planned well.
5. Leverage investing
People often get carried away with the kind of returns some funds have generated in the year 2017. One should never make a short period of outperformance as the base while investing. We have often come across scenarios where an investor has invested in mutual funds by leveraging their capital structure (in simple words by taking debt at a certain cost from an unorganized market). This is not an ideal approach as the investor may lose out on the alpha and also may distort his/her repayments to the creditor if the returns don’t pan out the way it is expected.
Thus, to recap, while we believe mutual funds are undoubtedly one of the best avenues of investment currently across any asset class such as real estate, gold, crude oil and the likes but there has to be a financial discipline. As we tend to become more globalized and developed, the likelihood of risk and turbulence increasing is high.
In case none of the reasons listed above applied you, go ahead and invest wisely in mutual funds. Here is a complete guide to investing in mutual funds for beginners.