Mistakes to Avoid While Choosing Best Performing Mutual Funds

Investors often tend to pick only those funds for investment that has delivered attractive returns in recent years. With time, if some of the funds fail to perform, many investors get tempted to pull back their money to invest in other high-performing funds.This frequent shuffling of money from one fund to another may not be fruitful always since it leads to additional costs in the form of the expense ratio and tax burden. Also, it may fail to deliver consistent results in the future due to constant changes in the portfolio.Financial experts and planners suggest that to leverage the changing market conditions and ensuring maximum returns, you must focus on allocating your assets to different asset classes . By investing in different asset classes such as bonds, equities, debentures, etc., you can make sure that all your eggs are not in a single basket.Let’s understand further about asset allocation and its significance:

Let's take an example – There are two shopkeepers A and B. Shopkeeper A sells umbrellas, whereas shopkeeper B sells umbrellas, sunglasses, and jackets. There are chances that A generates higher revenue during the rainy season only, whereas B is better positioned to earn profits in every season – rainy, summer or winters. Keeping different items for different seasons in stock will help B to even out its returns regardless of the season.The same is the case with asset allocations. When we diversify our investments to different classes of financial instruments (Stocks, Bonds, Cash), we are trying to even out the overall return delivered under different market conditions. It may (and mostly will) happen that one asset is outperforming under a market condition, whereas another asset is underperforming in the same market condition. The overall result here will be less volatile in the case of a diversified portfolio.The asset allocation may depend upon the following factors:

• Time Frame If your financial goal is due in the longer run (Ex. Retirement corpus), say 15-20 years, you can bear to invest in risky instruments. And if you are creating a corpus for a goal due in 5-10 years, a more dependable instrument will suit your requirements.
• Risk Appetite Your asset allocation will also depend on the level of risk you are ready to take for chances of higher returns in the future. A traditional investor will be more interested in low-risk instruments, whereas an aggressive investor will prefer high-risk instruments.
• Your Age When you’re young, you can take slightly take more risks and consider high-return potential investments that will most naturally carry high risk too. However, as you age, you would need to consolidate your portfolio to ensure it matches your lower risk appetite.

You must also ensure that you use the right asset allocation strategy while diversification to improve upon chances of reaching your financial targets. The strategies may be:

• Conservative: more exposure to instruments with stable returns(such as debts).
• Moderate: Balanced allocation to debt and equity.
• Aggressive: More exposure to risky investments(Such as equity).

You can allocate assets in your investment portfolio using the below steps:

• Ascertain Your Risk Appetite Look into your financial status and analyze your capacity to take risks. You must understand your risk appetite – low, moderate, or high. A financial advisor can also help you in estimating your risk tolerance correctly.
• Financial Goals Determine your financial goals, the time horizon, and the average annual return required to meet these targets.
• Choose Asset Allocation Now, depending upon your risk appetite, financial goals, time horizon, and the required rate of return, you must arrive at a suitable asset allocation. If you do not have the necessary expertise, it is suggested to consult a financial expert for determining the ideal allocation for your portfolio.
• Review it Regularly Once the asset allocation is done, you need to revisit it periodically to ensure that it fits your changing requirements and re-align it if required.

While asset allocation plays a vital role in improving your chances of higher return, it works only if it has been done, keeping in mind some important points:

1. Keep From Over Diversification Buying too many stocks or even mutual funds and especially from a single sector, can lead to over-diversification that may not be profitable beyond a certain point. Also, maintaining and tracking a large number of funds becomes difficult.
2. Know When to Exit a Fund Buying a fund doesn't mean that you need to hold it till the end. You must keep track of its performance; if it feels worthless to stay invested for a longer time, you may decide to exit from it. However, stay away from exiting a fund every time the market hits a low. These are cyclical movements, and fund managers are equipped to ride the fund through the cyclical highs and lows.

Investing only in the best-performing mutual funds is not the right strategy. Rather look for optimal diversification of your portfolio, keeping in mind your risk appetite and financial goals. It is advisable to seek expert advice to get the best possible asset allocation done.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.