5 Indicators That Highlight an Unworthy Mutual Fund Investment

Relatively mutual funds are considered safe investments as compared to direct investments in stocks or bonds and can be seen as an ideal option for investors to diversify with minimal risk. However, even mutual funds carry certain risks and may affect your portfolio performance.

You must have heard someone say that their mutual funds are not generating substantial returns or they have lost money in the same? One might also experience times when their investment in a mutual fund has been a major disappointment.

However, on the other hand if you stay invested in mutual funds for extended period you may generate good returns after the investment duration is over. Especially when it comes to equity mutual funds, long-term investments assist you to get the best out of your investments. Having said that, it is of utmost importance that you choose worthy mutual fund schemes and keep track of your investments.

In order to allow your mutual fund portfolio to keep generating decent returns, it is crucial to avoid investing in unworthy mutual funds that may plunge your portfolio performance. As an investor, you need to keep one thing in mind. Anybody can enter mutual funds at the right time, but only a wise investor can avoid unworthy mutual fund investments.

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An investor must consider a number of qualitative and quantitative variables when choosing whether to invest in a mutual fund. On the contrary, to improve your portfolio performance, you should also be aware of a few indicators that guide you to avoid or eliminate a bad mutual fund investment.

Let us try to understand these few indicators that highlight an unworthy mutual fund investment:

1. The High Expense Ratios

The amount that an asset management company charges investors to manage an investment portfolio, a mutual fund, or an exchange-traded fund (ETF) is called the expense ratio, in which the ratio represents management fees and operating costs of the fund.

The expense ratio may vary for each fund, while for an actively managed portfolio it is about 0.5% to 0.75%. It can also go higher up to 1.5%. A mutual fund does not deduct the expense ratio all at once at the time of purchase. It is deducted on a daily basis after calculating its per-day expense. A high expense ratio may be a concern for investors, meaning one has to bear the expense at the time of redemption of the units, and it may reduce the amount of returns generated.

Thus, investors should to avoid investing in mutual funds that carry a higher expense ratio. Do note higher expense ratio does not mean higher returns or vice versa. Mutual fund schemes with lower expense ratios can also generate significant returns depending on dynamic market conditions.

2. Consistent Underperformance

Although past performance of a mutual fund scheme does not guarantee future returns, it can help you make an informed choice by providing some insight regarding how the fund has performed in the past during distinct market phases. While evaluating the scheme you are willing to invest, have a look if your fund is tending southwards in a consistent manner. However, a single month's poor fund performance should not trigger you into a defensive mode against that scheme. Instead, compare the fund performance for a longer period say 5-10 years and still if you see a low performance avoid investing in that fund.

There can be a number of reasons behind your fund's dipping performance including market correction, scheme's exposure to an unsuitable sector or theme at an inappropriate time. In yet another case, the debt fund may hold investments in low-credit rated securities. If your fund's inferior performance can be attributed to any one of these, you may avoid investing in any such schemes.

3. Unreliable Investment Strategy

While investing in actively managed mutual funds, all the investing work is done by the fund managers; investors cannot determine the exact composition of a fund's portfolio, nor can they directly influence which securities the fund manager can buy. Here having a robust investment strategy is crucial, as it gives you a view of how fund managers will be constructing the portfolio.

If any mutual fund scheme you plan to invest in holds an investment strategy that is new or there is no sufficient data to analyse the success of this strategy, you should avoid investing in it. Consult a professional financial advisor rather than jumping into mutual fund schemes or invest only after it built a reliable performance track record. So while picking a mutual fund, it's important to research the fund's investment strategy to avoid unworthy mutual funds in your portfolio.

4. Unstable Fund Management

The expertise, knowledge, experience and past performance of the fund manager, research team etc., are important factors to consider while selecting a worthy mutual fund scheme. However, if there is a fundamental shift in focus - for example, frequent churning, it is bound to impact investors.

You see, a fund's management team could be its foundation and a key factor in determining whether it succeeds or fails. A scheme's fund managers are in charge of stock selection, interest rate forecasting, and market timing. The funds with consistently effective fund managers are typically recognised for generating substantial returns. The frequent change of fund managers, however, may also be a warning flag. Even if it could be challenging to keep track of a fund manager's performance, it is nevertheless important to consider their track record and credibility. So, this is an indication that a lot of investors miss or fail to take into account before making a mutual fund investment.

5. Misalignment With Your Financial Goals

Timing the markets is something that should always be avoided because the more one tries it, the more the risk of losing. Market timing is the responsibility of fund managers. Hence, if you possess the basic knowledge of picking the right fund, then there is not much worry about the market's erratic ups and downs. However, as an investor, you must place attention on one aspect: aligning your mutual fund investment with your financial goals.

It is always beneficial to make investments based on certain goals rather than investing haphazardly. Moreover, it is important how you implement the link between your reasoning and your goal of selecting the most suitable mutual fund scheme. In case you invest in a mutual fund scheme based on past performance, and it does not align with your goals, it is a pointless investment.

To conclude...

There is no doubt that mutual funds are easy, and there is one for everyone. If investors analyse the performance of their investments to get an insight into the sustainability of the funds, mutual funds can bring superior returns.

Although one may have chosen a fund with a great past record, however, one cannot be always certain about the market conditions. For example, market fluctuations due to recessionary risks, an increase in interest rates, etc., can affect your mutual fund investment. Even the best mutual funds may suffer in these difficult circumstances. As a result, it's crucial to invest in a scheme that offers a well-diversified portfolio of securities to assist you to withstand times of high market volatility.

Nonetheless, there have been instances of investors choosing poor investments even after using all the tricks of the trade. Make sure you are not one of them; therefore, the best way to avoid unworthy mutual funds investment is to take your time to evaluate the scheme and understand the indicators mentioned above and make informed investment decisions.

MITALI DHOKE is a Research Analyst at PersonalFN. She is an MBA (Finance) and a post-graduate in commerce (M. Com). She focuses primarily on covering articles around mutual funds including NFOs, financial planning and fixed-income products. Mitali holds an overall experience of 4 years in the financial services industry.

She also actively contributes towards content creation for PersonalFN’s social media platforms in the endeavour to educate investors and enhance their financial knowledge.