C. FACTORS WHILE PICKING A MUTUAL FUND
· Your chosen funds should clearly say where it will invest and how, without being too restrictive in its objectives, and demonstrate the ability to stay honest to its clear objectives and strategies.
· The fund house should also have an investment philosophy that permeates most of its products, and ensure that the fund managers are different for diametrically opposite approaches.
· Ensure you buy into a specified, comparable, competitive product that is managed transparently.
· Do not mix up market timing and asset allocation while making your fund selection decision.
· Choose a fund through peer performance ranking across a common time period, preferably from within the top 25% of a specific fund type.
· As no single fund stays in the top quartile at all times, check how soon it rebounded after slipping, and whether it continued to stay in the top 50% for over a year.
· Review annually and replace a laggard if it slipped for four quarters in ranking, as the fund manager cannot correct such downfall soon enough.
D. COMMON INVESTING MISTAKES IN MUTUAL FUNDS
1. NO ASSET ALLOCATION STRATEGY
· Ineffective diversification has both allocation and risk/reward characteristics which do not accurately represent the chosen investment objectives in a given portfolio.
· Over-weighting and under-weighting of fund categories are significant percentage imbalances in allocation.
· In order to avoid the pitfalls of haphazard fund selection, develop a detailed asset allocation strategy which accurately represents your investment objectives and preferences.
2. OVER-WEIGHTING IN HIGH-RISK, NON-DIVERSIFIED FUNDS
· This results in excessive volatility, which can cause disappointing portfolio performance because the risk is highly disproportionate to overall profit potential.
· Over-weighting is more likely to be a problem in portfolios with aggressive risk tolerances.
· High-risk, non-diversified categories include small-cap growth, emerging markets and sector funds.
· In bond categories, emerging market and certain high-yield funds are also high risk.
· Around 5-30% of total portfolio assets are an acceptable percentage of high-risk, non-diversified funds, depending upon the choices of aggressive, moderate or conservative risk tolerances and growth, balance or income-oriented return objectives.
· Treat high risk, non-diversified mutual funds as a supplement without increasing overall risk.
3. DUPLICATION OF FUND CATEGORIES
· This leads to inefficient diversification and occurs when an investor has two or more funds with identical objectives.
· Such arrangement lacks the variety of distinct risk/reward characteristics of ideal diversification.
· To avoid duplication, it is best to represent a fund category with just one fund.