Mutual funds offer investors unique opportunities to build wealth through consistent and disciplined market-linked investments. While MFs attract millions of new investors every month, most novice investors fall prey to some common red flags that derail their investments. To help avoid this, we’ve curated this mutual fund investment guide on the 5 red flags a new mutual fund investor must avoid when choosing funds and starting their investment journeys.

Before you start investing in mutual funds, here’s a list of the 5 red flags you must consider:

No. 1: The risk and return trade-off varies from one fund category to another

If you think the risk and return quotient of all mutual fund schemes are the same, think again. This misconception is a major red flag and can cost you dearly. The risk-return trade off of different mutual fund segments vary greatly. Generally, equity mutual funds have a higher risk exposure and offer potentials for better returns. Debt funds, on the other hand, offer lower returns but tend to be safer options in terms of handling volatile markets. Therefore, if you’re making investment decisions solely based on the return side, you can lose money. It’s crucial to identify this red flag and assess the risk-adjusted returns when selecting a mutual fund.

No. 2: Picking funds based solely on past performance

Another red flag new mutual fund investors should be wary of is picking funds simply based on the past performance of the fund. If you’re choosing funds on the basis of the returns generated in the last year or so, you may not be making a wise choice. While assessing past performances is a crucial part of the selection process, past record does not guarantee future returns. Therefore, taking calls on the basis of such indicators can be detrimental to your portfolio. Instead, you should choose funds that align best with your financial goals and risk appetite, while factoring in performance consistency as well. Significant inconsistency in returns in the last 5 years is a major red flag you should avoid.

No. 3: Over-diversifying pitfalls

Another common red flag for a new mutual fund investor is treading the diversification line. Diversifying your investment across asset classes and sectors helps mitigate investment risk and optimise returns. However, diversification only works until a certain point. Beyond that, the more you diversify, the more you limit your gains. As a beginner, you should understand the basics of this to avoid investing in similar mutual fund schemes that offer zero diversification benefits to your portfolio.

No. 4: Category v/s fund rationale

A common investment mistake new investors make is to include mutual fund schemes that are ranked the highest on aggregator and AMC websites. Instead of reviewing the fund category, they simply select the fund for its high ranking and favourable return estimates. Adopting this strategy can pose a significant risk, especially if the fund falls under a category that doesn’t align with your investment objectives. Therefore, it’s always prudent to first assess and narrow the fund categories you wish to include in your portfolio based on your risk appetite, goals, and time horizon. As a new mutual fund investor, you should be more conscious about this red flag while investing.

No. 5: Returns variability

As a new mutual fund investor, you should be careful about how returns are assessed and quoted. When people talk about MF returns, it’s generally the annualised returns. You may be under the misconception that returns remain consistent year after year. This is a major red flag you should avoid while investing in mutual funds. For instance, if a mutual fund scheme offered 10% return last year, it does not guarantee a 10% return this year as well. In fact, returns can be negative or zero as well depending on market conditions and the fund’s performance. In short, you should be prepared for variability in your annual returns.

• Ignoring risk-return trade-off across different mutual fund categories can result in losses.
• Basing investment decisions on the past performance of the fund and assuming consistent future returns are additional red flags to avoid.
• Over diversification into similar funds is a top red flag you should avoid while investing in MFs.

Understanding and acknowledging the 5 common red flags for new mutual fund investors is crucial to make informed decisions and avoid disappointments in the long-run. Educating yourself about the various red flags in mutual fund investing helps make the investment journey smoother.

Now that you know all about mutual fund red flags for new investors, it’s time to get started with your investments on the Bajaj Finserv Mutual Fund Platform. This intuitive platform let’s invest in mutual funds through SIPs starting from just Rs. 100. Additionally, you get to curate a customised portfolio with funds from different categories. Further, you can compare 1000+ mutual funds and estimate returns using the Mutual Fund Calculator.