Trading and investing are two terms that are often used interchangeably. But there is a stark difference between the two. Investing involves building a diversified portfolio of assets and staying with it through market ups and downs to earn fruitful results over the long term. Trading, on the other hand, involves entering and exiting assets within a short period to make quick gains.

While both approaches have the potential to generate significant gains for investors, most retail investors may be better off investing rather than trying to be successful with trading.

Notably, active trading is usually associated with stocks. The term however is not synonymous with mutual funds. Yet many investors attempt to time the market while buying mutual funds. However, in my view, you should not invest in mutual funds with the mind of a trader.

Why you should avoid trading in mutual funds like stocks?

If you read my recent article, you would know that many investors look at the NAV of mutual funds to determine whether a scheme is available cheap or expensive and subsequently trade in them. Such investors often dump a well-performing mutual fund which has grown in value to substitute it with a scheme available at a low NAV.

What they forget is that unlike in the case of stocks where the price determines whether it is undervalued or overvalued, the NAV of a mutual fund only reflects the current value of all securities the scheme holds in its portfolio.

Timing your entry and exit in equity mutual funds can appear as an easy way to sail through the volatile nature of the market. But timing the market is not everyone’s cup of tea since market movements are highly unpredictable. You can never tell if the market has bottomed out or whether it will keep rising after reaching a peak. Consequently, there is a high chance of your trades not pulling off as expected. This can lead to the following conditions:

  1. It can put a brake on the process of compounding wealth which may negatively impact the overall growth of your investment portfolio.
  2. Frequent trading attracts taxes and exit load which can eat into your overall returns.
  3. You may end up earning lower returns than expected which in turn can create a hurdle in achieving your financial goals.

As you may know, mutual funds are professionally managed. It is the job of the fund manager/s to select stocks at appropriate valuations based on their investment objective. During a market correction, they aim to identify and invest in quality stocks available at attractive valuations, which results in higher gains when the market starts ascending again. Likewise, when the market is overheated, they utilise their knowledge and expertise to determine whether a stock/sector still holds potential or whether there is a need to replace it with a better alternative. This strategy enables mutual funds to participate the market rallies and also protect against the downside risk during bearish phases.

Thus, it is the price at which the fund manager/s buy and sell the securities that matters, and not the NAV at which you, as an investor buy the mutual fund units. Remember, the NAV of mutual funds only tells how much your investment has grown in value, but it does not indicate the future prospects of a mutual fund scheme. This makes it irrelevant to use the NAVs as a tool to trade in mutual funds.

Even though there can be a lot of uncertainties and volatility in the short term, equity market is known to reward investors who choose to exercise patience and a disciplined approach to investment. Therefore, instead of timing the market, mutual fund investors should focus on ‘time in the market’ to earn better returns over the long term.

Further, it is important to note that investments in equities take time to grow and generate meaningful returns. So, instead of trading, it is advisable to create a diversified portfolio of mutual funds and stay invested with a long-term view of at least 5 years. Avoid getting influenced by short-term market movements. Investing via SIP is great way to make timing the market irrelevant as it allows you to invest a fixed amount regularly to achieve your various goals.

This article first appeared on PersonalFN here

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