The first thing to answer before you start investing is to know “WHY” you are investing in Mutual Funds.
- Debt Funds - To build a safety net, achieve short term goals and earn higher tax efficient returns compared to fixed deposits.
- Equity Funds - To create long term wealth and achieve goals
Many Investors just look at the best performing funds. They would google - Top 5 funds for 2020 or Top 5 funds for 2021 and invest their money in the fund names that appear. So much so that most of the time they do not even remember the name of the fund. So many times, we have asked people - which fund have you invested in and I would get an answer saying - Umm HDFC bank? Kotak? Something DDFC…basically full confusion and no research.
Yes, when you don't know how to invest and you want to invest, choosing the best funds based on recent past performance seems the easiest choice to make. However, it would also turn out to be a bad choice.
Studies have proven that selecting mutual funds based on high-performance track records is naïve. The Star rating of various mutual funds keeps changing, a fund that is top rated in this one year, is hardly the top-rated fund in the subsequent years. Tim Courtney, a chief Investment advisor of US-based Burns Advisory, did backtesting of past performance of the funds most highly rated, he found that they usually performed poorly after they have gotten 5 ratings. Hulbert financial digest, an investment newsletter, found that if investors continually adjusted their mutual funds' holdings to hold only the highest-rated funds, a total stock market index would have beaten them by 45.8 % in the past decade (he studied funds from 1994 to 2004 in the USA). In fact over the years, it has gotten even more difficult to beat the markets and get alpha on your investments. - extracts from Millionaire extracts - How to build wealth living overseas by Andrew Hallam
Recently, even ET money conducted a similar study for the Indian Mutual Fund market and tracked the returns investors would make. As per the study, they tracked that if investors followed a buy and sell strategy with top rated mutual funds i.e. they bought the best fund and then sold them when their rankings fell, they would make a CAGR of 12.6% in the past 10 years (without accounting for the cost of investing, selling and taxation on the same). Now, instead of doing this, if the investor would have only invested in an index fund in the past 10 years (2010 to 2020), they would have made a return of 12.2%.
The cost of transactions such as brokerage, exit load, STT and capital gains taxes (payable every time you book gains on mutual fund transactions) would further reduce your returns in case of a buy and sell strategy based on the top ranking fund. Also, it is not feasible to follow this approach once your portfolio grows too much.
Some learnings from the above 2 studies are as follows:
- Chasing past performance and looking out for best returns is a futile activity, it is not giving you better performances. It is only tiring you and keeping you away from focusing on important parameters.
- Invest as per your goals and risk profile, finalize the funds and stick to them. Rather than looking for quick gains, understanding wealth creation takes consistency and discipline is the way.
- If you want to learn on what parameters to check to select the right fund (please stop using the word best funds), check our blog - Factors to check.
- If you really want to invest and make a financial plan - you can reach out to us by filling this google form or at firstname.lastname@example.org We are SEBI registered investment advisors and can help you make sound investment decisions. You can read about our advisory services at ria.wealthcafe.in
Wealth Café Advice - “Past performance is no guarantee of future results.” In search of looking for the best, you are missing on the right and the time a fund needs to create wealth and achieve your goals.
Check our course- NM 104: Basics of Mutual Funds - to learn more about Mutual Funds in detail.
Disclaimer: - The articles are for information purposes only. Information presented is general information that does not take into account your individual circumstances, financial situation, or needs, nor does it present a personalized recommendation to you. You must consult a financial advisor who understands your specific circumstances and situation before taking an investment decision.