Why some people lose their money in mutual fund investments

Why some people lose their money in mutual fund investments
Why some people lose their money in mutual fund investments
Table of Contents

“I have earned good returns in the last ten years through SIP investment in different mutual fund schemes.”

“I lost my money in mutual fund investment. I would prefer to invest in bank fix deposit.  At least my money will remain safe.”

Quite often, we hear such statements from people who invested in mutual funds. Why some people lose their money in mutual fund investments while and some people gain adequate wealth through mutual fund investments on the same investment route.

Before going in detailed analysis of both the above statements, let me share with you some examples of different mutual fund investors –

Case 1

A mutual fund equity scheme was launched in the year 2006. Three friends separately invested Rs 25000 each at the time of launch of that scheme. During the down trend of market in the year 2008-09 all the three friends reacted differently towards their investments.

The first friend was very depressed and decided to withdraw the investment immediately without considering anything else. He suffered a loss of principle.

The second friend was also suffering from fear of loss in this equity investment. He partially redeemed the investment and reinvested it in a debt fund having a high credit rating. During the second half of 2009, the market started correcting and initiated an upward move. As the market made a small correction, he redeemed all his equity investment. He saved his principal investment but earning on investment was insignificant.

The third friend was also in dilemma about the investment he made in mutual fund. Instead of feeling panic due to this recession, he started analyzing the previous market trends of such volatility along with the status of fund managers managing the scheme he invested in.  He consulted and followed the advice of seasoned financial advisors. He remained invested in the same scheme with endurance. Soon the market started showing the upward swing.

The recovery brought back hope and reinforced his faith in mutual fund investments with prudence. This is his 15th year of that investment and his total earning on investment is more than 1.5 lakh apart from the principal invested i.e., Rs 25000. 

Case 2

Mohan and Suresh started investing in mutual funds after a thorough financial planning as per their future financial goals at the age of 27. One of their colleagues Vijay, aged 49, rarely invests any money except the bank fixed deposits. During a family gathering of all the three co-workers, Vijay came to know about the good returns Mohan and Suresh are earning on their mutual fund investments. Apparently, he did not show any curiosity in that gathering but Mr. and Mrs. Vijay decided to make some investment in mutual funds. They invested a lump sum amount in a scheme showing high returns. The scheme was already over rated. Soon the market went down and instead of earning, their mutual fund investment statement started showing shrinkage in the principal amount. They panicked and immediately redeemed their investments and ultimately suffered a loss in their investment.

Why some people lose their money in mutual fund investments – An analysis

Both the investment scenarios given above are very common. It reflects that undue fear, investment under herd mentality, Lack of basic investment knowledge and some other psychological factors may lead an investment towards losses.  

In the first scenario the third investor was well versed with the volatility pattern of the market. He did the required home work like analyzing the prospects of the scheme, the credentials of fund managers of the scheme, what the seasoned investors are doing with their investments, taking consultation of good investment advisors before taking a decision to remain invested or redeem the investment. Top of all, he ignored all the rumors and unauthentic information and kept a solid control over all the emotional biases. The first and second investors flowed in the market and could not make a proper return on investment.

Second scenario is an example of making investment under greed and herd mentality. Mutual Fund offers number of schemes carrying different features and benefits. It is the responsibility of the investors to choose the best suitable scheme as per their investment objective. Mr Vijay has invested in mutual funds only because of his co-workers are investing and getting good returns. He invested in a scheme looking lucrative but not analyzed it property on the basic parameters and sold the units when the market was on down trend.

In both the cases, investors who suffered a loss on their mutual fund investment had not even applied the basic rule of market that customer increases purchasing when a product is offered on discounted price by the seller. When the units are available at reasonably lower NAV and the scheme prospects are good, a wise investor would prefer to purchase the additional units along with holding the units they are already having in their hand. Selling such units in an impatient manner may be a wrong decision for long term investors.

Factors that may lead you towards losses in mutual fund investments:

  1. Lack of basic knowledge
  2. How to make a sensible and goal-oriented investment is not properly known to majority of mutual fund investors in our country. Most of them take advice from their friends who already invested in mutual funds, go through some YouTube videos, do a little brainstorming with some mutual fund investment websites to check the historical performance and start investing. They even don’t know the detail of basic parameters on which the performance of a scheme should be checked.
  3. Many investors do not understand the difference between trading and investing. They purchase the units and if it does show a growth for few months, they sell it and go for the new units. Investors should understand the fact that mutual fund products are not suitable for frequent trading. It gives handsome returns on long term investments.
  4. Investors do not select the right scheme matching with their investment need. This may defeat the purpose of their investment.
  5. Over expectation on returns:

A person Rohan earned 18 percent return on his mutual fund investment, seeing that one of his colleagues Rahul also invested in mutual fund to get similar returns. In the first year he received a small return, but in the next two-three years it increased gradually, but it remained around 10 percent. Rahul started getting worried that I was not getting the return of 18 percent and in the same disappointment, he redeemed all his investment.

What mistake did Rahul make? He did not see what the investment period was of his friend Rohan, who got a return of 18 percent. He was earning good returns and if he kept his investment, he could have got more than 18 percent returns but withdrew his fund in the short term. Over-expectation from our investments can lead us to wrong decisions.

  1. Wrong Timing of entry and exit:

It is a tendency of general investor to sell the mutual fund units during the down trend of the market and purchase the units when market is going upwards. During the down trend the unit prices go down and if we sell our units at a lower price, certainly it will attract a loss in the trade. During upward trend unit prices keep on increasing. If we purchase the units during this time, certainly the cost of acquisition will be high.     

So it is important to decide the time of entry and exit in the market on the basis of proper analysis under a controlled bias free environment.

Risk is a part of life. Wise people balance it with required safety measures:

 “Mutual Fund investments are subject to market risks, read all scheme related documents carefully.” The disclaimer issued by mutual fund has got a deep sense of responsibility on the part of investors. Very few investors understand the importance of this line.

Every investor should understand the features and benefits of the scheme before investing in a particular scheme. If they don’t have proper exposure or time constrains, it is always better to consult a professional mutual fund advisor.

Common myths which need to be analyzed before investing

1. It is generally said in mutual fund investments that Investment with “higher risk turns into higher returns”. It is not always true in the world of investments. The answer lies in the lines of this proverb itself. If it gives higher returns always, then why is called risky? It should be called safest. Return on investment depends on so many other factors also. Investors should analyze all the related factors in line of their age, earning status, time horizon, risk taking capacity and investment objective.

2. It is presumed in the financial market that whatever units go down always comes up with time and vice versa. Time tells us that it is not a thumb rule. Performance of stocks in the long run depends upon the strong fundamentals of the business enterprise. Many examples are there when the stocks of well-known companies have fallen down and never recovered in the future. Simultaneously companies having strong fundamentals revived their stocks with the passage of time.

It is therefore important for every investor to avoid random mutual fund investment. Wrong advise, biased investment decisions, improper analysis, faulty asset allocation, impatient investment and redemption decisions can cause losses or lower than expected returns.

F. Behavioural Bias in Investment Decision Making

An investor needs to make many decisions when it comes to investment, like –

  • which asset class to invest in
  • how to invest
  • timing entry and exit
  • reviewing and rebalancing portfolio

These decisions must be taken by analysing –

  • expected performance of the investment
  • risk associated with the investment

However, often what happens is that the investor takes his decision not by careful analysis of relevant information, but based on his behavioural bias like confidence bias, herd mentality, choice paralysis. These are discussed below – 

  1. Optimism/ Confidence Bias
  • Investors acquire confidence and believe they can continuously outperform the marketbased only on some success.
  1. Familiarity Bias
  • Investors invest only in those stocks and sectorswith which they are familiar and have more information.
  1. Anchoring
  • Investors continue to rely on old informationwhich is no longer relevant for decision making. They dismiss the new information as irrelevant. e.g., an investor waiting for the right price to sell, even when new information suggests otherwise.
  1. Loss Aversion
  • Fear of loss of money holds backa lot of potential investors.
  • Sometimes, an investor also continues to hold on stocks which are not expected to perform well in future, just so they don’t have to sell them for a loss in the present.
  • If investors feel that there is a possibility of loss in short-term then they prefer to do nothing, even if taking the risk might lead to gains in the future.
  1. Herd Mentality
  • Some investors believe that others have better information and tend to follow others’ investment decisions.
  • This leads to a lot of investors entering the market when it is already overheated and poised for correction. Herd mentality also leads to creation of bubble in the market.
  1. Recency Bias
  • People take recent events and extrapolate themto predict future.
  • If there was a crash in the market some time ago, people place their money in safe assets. If there was a bull market, people place their money in risky assets even when the sound investment advice is suggesting otherwise.
  1. Choice Paralysis
  • If there are too many investment options or too much information available, then the investor might feel overwhelmed and do nothing.

These behavioral biases also contribute to the losses while considering Mutual Fund Investments and hence must be avoided to take rational and wise investment decisions.

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