Investing in a mutual fund based only on its past performance may not always lead to the right decision. While mutual fund performance over the past can help you understand how a scheme has performed in different market conditions, it does not guarantee similar returns in the future. Reviewing past performance mutual funds across 3-, 5-, and 10-year periods can help you assess consistency and compare returns with benchmark indices and similar funds. However, you should also consider the fund's investment strategy, risk level, portfolio, and the fund manager's experience before making an informed investment decision.
Why do investors invest based on past returns?
In the last 5 years, the Indian mutual fund industry has seen a tremendous increase in the number of investors and a lot of these investors invest based on past returns.
Investment in mutual funds often becomes a showcase of mutual funds' past performance. This is the general strategy with most of the investors, but why is so much importance attached, especially in India? Let's check out why there is this trend.
- Historical performance indicator: Many investors rely on the past performance of mutual funds as an easy indicator of what the fund can accomplish. It is a concrete record that can be easily analysed and compared with other funds. Common sense will tell you that if a fund has done well in the past, it will carry on doing well in the future.
- Media influence: The financial media in India tends to highlight top-performing funds a lot of the time, focusing on their short-term returns. Most of the investors, therefore, if they are not doing research to understand what drives such returns, are influenced by this visibility.
- The evaluation of past returns is relatively simpler than dissecting complex financial statements or getting onto the prediction of future market conditions. For an average investor, it's way easier to look at numbers that describe growth over years and make decisions based on these data.
- Peer influence: Most of the persons, while deciding about investment, will take advice from their family, friends, and colleagues. So, the discussion about the mutual fund inside his personal network is likely; funds which are giving good returns are discussed, and there is likely to be a bandwagon effect.
- Performance chasing: This is the psychological aspect whereby the investor chases the mutual funds' past performance. They observe a fund doing very well, and out of fear of missing similar gains, the performance chaser invests to just catch the high returns wave.
How should you be investing in mutual funds?
a. Through a mutual fund distributor
AMFI-registered mutual fund distributors help you choose suitable mutual fund schemes and complete investments. They earn commissions from AMCs, so they usually do not charge investors separately. Regular plans have higher expense ratios than direct plans.
b. Directly with the AMC
You can invest directly through an AMC's branch or online portal after completing your KYC. Direct plans have lower expense ratios and may suit investors who understand mutual funds and their risk appetite.
c. Through Registered Investment Advisors (RIA)
SEBI-registered Investment Advisers recommend direct plans and charge a fee instead of earning commissions. Compare their services and costs before investing.
d. Through Registrars and Transfer Agents (RTAs)
RTAs process mutual fund transactions for multiple AMCs. They allow investments in both direct and regular plans through a single platform.
e. Online
Complete your KYC and invest through AMC websites or authorised online platforms after selecting schemes that match your financial goals and risk profile.
Mantras to keep in mind while investing in mutual funds
Here is a strategic approach and some of the key mantras to guide you: remain invested, stay disciplined, diversify across fund types, and consider professional advice towards optimising your portfolio.
Remain invested
- Long-term perspective: Stay with your investments through gyrating markets if you want to enjoy potential long-term gains. In other words, you allow your gains to grow. Staying invested gives a chance for your earned amount to compound, thus increasing potential returns.
- Market timing futility: Steer clear of this form of market timing that usually proves futile and fraught with greater risks.
Stay disciplinary
- SIP (Systematic Investment Plan): Regularly investing a fixed sum to average out the cost of purchase and reduce market timing risks.
- Goal alignment: All investments should align with clear financial goals to help maintain focus and not make decisions on the basis of prevailing market sentiments.
- Regular reviews: Periodically, you will have to review your investment portfolio to make sure that it still fulfils your financial goals and matches the risk tolerance at hand.
Do a plan for a variety of mutual funds
- Diversification: Spread your investments across the different categories of funds to reduce risk and increase the potential return.
- Risk management: You should customise your mutual fund selection to your risk capacity and invest in a mix of equity, debt, and hybrid funds.
- Strategic allocation: Use asset allocation strategies to adjust your investment spread according to changing market conditions and personal financial situations.
Help consider
- Expert advice: Expert investment strategies, offered by financial advisors, will help provide insights to the peculiarities of such a market.
- Research and resources: Leverage the tools and research content on our investment platform to make informed decisions.
- Portfolio management: Businesses should consider reviewing and use managed services for the portfolio rebalancing whenever they require adjusting to the market changes effectively.
How to track the performance of a mutual fund?
1. Compare the fund’s performance with its benchmark and peers
Compare the fund’s returns with its benchmark and similar funds. Consistent outperformance reflects effective fund management.
2. Check the expense ratio of funds
A lower expense ratio can improve long-term returns. However, assess it along with the fund’s performance and investment strategy.
3. Check the fund’s historical performance across market cycles
Review performance over 1, 3, 5 and 10 years. This helps you assess consistency across different market conditions.
4. Check the strength of the portfolio
Check portfolio diversification, sector allocation and holdings. For debt funds, review credit quality and maturity profile.
5. Analyse the fund’s risk-adjusted returns
- Sharpe ratio: Measures returns earned for the level of risk taken.
- Standard deviation: Shows how much returns fluctuate over time.
- Beta: Indicates the fund’s volatility compared with the market.
6. Check portfolio turnover ratio (PTR)
PTR shows how frequently securities are traded. Compare it with the fund’s performance to judge whether higher trading costs are justified.
Disadvantages of relying solely on past performance of a mutual fund
Relying solely on the past performance of mutual funds when making investment decisions is a common practice, but it comes with significant risks. Here are some of the key disadvantages to consider:
- Mutual funds' past performance is not a guarantee of future results: This is a standard disclaimer for a reason. Mutual fund returns are influenced by a variety of changing factors including market conditions, economic cycles, and sector-specific issues. What worked well in the past may not necessarily do so in the future.
- Market conditions vary: The financial markets are dynamic and the factors that led to a fund's exceptional performance in the past may no longer be present. Economic environments change and what drives one market cycle can be irrelevant in the next. For instance, a debt fund that thrived during a period of falling interest rates may not perform as well when rates rise.
- Management changes: Mutual funds' past performance can also be heavily dependent on the fund manager and their team. Changes in management can alter the strategy and performance of a fund. Investing based on past performance without considering a recent change in fund management might lead to unexpected results.
- Overlooking Expense Ratios and Fees: Funds that have shown good past performance may come with high expense ratios and fees that can eat into returns over time. Investors focusing solely on returns may overlook these costs, which can diminish net gains.
- Performance chasing: Investors often chase high-performing funds, leading to inflows that may not be sustainably managed. This can lead to a dilution of returns as more assets under management can sometimes make it harder to sustain high performance.
- Misaligned risk profile: A fund’s past performance might not reflect its risk profile. Investors might find themselves invested in funds with risk levels that do not match their own risk tolerance, potentially leading to uncomfortable levels of exposure during market downturns.
- Ignoring better options: By focusing only on past performance, investors might miss out on other promising funds that have the potential to perform well in the current or upcoming market conditions but may not have a long track record.
Factors to be considered while making an investment decision on mutual funds
Investing in mutual funds is a popular choice for many investors in India, but it requires careful consideration of several factors to ensure it aligns with your financial goals and risk tolerance. Here’s a detailed look at the key factors to consider:
- Investment goals: Define what you are aiming to achieve with your investment. Whether it’s saving for retirement, your child’s education, or building an emergency fund, your goals will determine the type of mutual fund you should invest in and the duration of investment.
- Risk tolerance: Understand your risk appetite. Different mutual funds have varying levels of risk based on their asset allocation. Equity funds are higher in risk with potentially higher returns, suitable for those with a high-risk tolerance, whereas debt funds are generally safer with lower returns, appropriate for conservative investors.
- Fund performance: While mutual funds' past performance isn’t an indicator of future outcomes, it can provide insights into how a fund has managed volatility and performed under different market conditions. Look at the long-term performance of mutual funds to gauge consistency, not just short-term gains.
- Expense ratio and fees: Check the expense ratio of the fund, which is the annual fee that the fund house charges for managing the money. A lower expense ratio can significantly affect net returns, especially over long periods.
- Fund management: The track record and stability of the fund management team are crucial. Experienced fund managers are likely to navigate market ups and downs more effectively than those less experienced.
- Asset allocation: The composition of investments in a mutual funds portfolio—equities, bonds, cash—is crucial. Ensure it matches your investment strategy. Diversification within the fund can help reduce risk.
- Exit load and tax implications: Be aware of any exit load charges if you withdraw your investment before a certain period. Also, consider the tax implications of your investments, as these can affect your returns. Long-term equity investments have different tax rules compared to debt fund investments in India.
- Investor reviews and ratings: Look at reviews and ratings from other investors and research agencies. This can provide an additional layer of insight into the fund’s performance and management quality. You can also compare mutual funds and their reviews and ratings on the Bajaj Broking website.
Considering these factors can help you make a more informed and suitable investment decision, ensuring that the mutual fund you choose fits your financial needs and investment profile. When investing in mutual funds, choosing between SIP (Systematic Investment Plan) and lumpsum investments depends on your financial stability and market timing.
Conclusion
In conclusion, while investing in mutual funds can be a lucrative opportunity, it's essential to approach it with a well-rounded perspective along with the mutual fund performance. By considering factors such as your financial goals, risk tolerance, fund performance, expense ratios, and fund management, you can make more informed decisions that align with your investment strategy. Additionally, be mindful of the exit loads and tax implications associated with your investments.
For those looking to explore a wide range of options, the Bajaj Broking website offers access to over 4,000+ mutual fund Schemes where you can also compare mutual funds. This platform provides a comprehensive suite of tools and resources, making it easier to compare different funds and manage your investments effectively. Whether you are a seasoned investor or just starting out, the Bajaj Broking website can be a valuable resource in your investment journey, helping you to navigate through the plethora of mutual fund choices with ease.
