Saturday, December 23, 2006

Five Common Investment Myths

To make informed investment decisions you have to shift through an overload of investment choices and advice. And this overload has led to the rise of a number of “investment myths”.

Investment advisors and agents use these myths to their advantage. As a result, the investor’s interest is often compromised with. Let us take a look at five common investment myths to enable investors to make well-informed investment decisions.

Rs 10 NAV makes a cheaper buy Thanks to the large number of new fund offers (NFOs) being launched by fund houses and the attractive commissions being offered thereon (vis-à-vis existing funds) to investment advisors/distributors, NFOs have emerged as the most frequently “recommended” investment avenues. Investment advisors often use the Rs 10 net asset value (NAV) as a factor in their sales pitch. In effect, they suggest that buying into the fund at Rs 10 makes it a cheaper buy. Nothing could be farther from the truth. The NAV is simply representative of the assets backed by each unit of the mutual fund (MF). Hence a Rs 10 NAV (offered by an NFO) is no cheaper than say a Rs 100 NAV (offered by an existing fund).

The long-term always pays off We are strong proponents of long-term investing in equities and equity-oriented avenues. However, along with the long-term investment comes a caveat - investors should be invested in the right avenue, i.e., in case of say, MFs, the right schemes. A bad investment stays unchanged even over the long-term.

Universally suitable investment avenues exist An investment can be termed as being ideal, if it is in line with the investor’s risk profile and can contribute towards achieving his investment goals. In effect, it’s right for the investor in question. Investing is a personalised activity and what could be right for one investor can be completely unsuitable for another. For example, a well-managed diversified equity fund with a fantastic performance history over a longer time frame and across market phases can make an apt fit in a risk-taking investor’s portfolio. But the same fund may not find a place in the portfolio of a 70-year- old gentleman who has no appetite for taking risk and accords importance to assured and regular income along with safety of capital invested.

SIPs are always right We have maintained that investors should invest using the systematic investment plan (SIP) route. However, SIPs need not always succeed or deliver the expected results. For example starting off an SIP (in isolation) without any investment objective or an SIP in a poorly managed fund is unlikely to serve any purpose. Similarly, an SIP, which runs over shorter time frames (like six months) may not even help lower the cost of investment, if the same coincides with a bull run in the markets.

There is no such thing as too much diversification Diversification across asset classes and investment avenues is vital. By doing so, investors can ensure that investment portfolio is insulated from a downturn in a given asset class/investment avenue. However, it is also pertinent that an optimal level of diversification be maintained. At times, investors tend to stretch diversification to absurd levels, by investing in just about any fund that comes their way. Often no thought is paid to the value, which the fund can offer to the portfolio or even the fund’s aptness. Eventually, investors are left with a portfolio that is fragmented. There is a cost associated with MFs, both in terms of money (entry loads) and time (to regularly track the funds). Instead, the right approach would be to have a well-diversified portfolio constituted of not more than 6-7 funds, which have broad investment mandates.
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