Equity markets go up, and investors get tempted to invest.
It tanks and they panic. They sell or stop further investments into equity funds.
And markets turn volatile, they procrastinate investment decisions.
Such erratic behaviour seems to be impacting overall growth rates investors see. A recent study found that returns of mutual fund investors (collectively) were lesser than that of fund returns. It was applicable not only across fund categories but also for different time horizons.
Equity fund investors, on an average, made 12.5 percent annually over the 15-year period ending Sep 2019, while it was 18.8 percent for the fund.
The results were consistent for the short-term period of five years, when equity fund investors earned annualised return of 5.8 percent as against 8.2 percent for the equity fund. In the Axis MF study, consolidated return of all investors into a fund was calculated based on its net sales figures and NAV performance.
What could explain the difference between fund and investor returns?
Moreover, some investors tend to churn portfolios at short notice. A mutual fund scheme tops the charts in a year and they invest in it. And the next year, they look for the new winners. Instead of looking at long-term performance, they keep hopping in and out of funds.
Timing the market
Often, some investors try to time the market. They move in and out of equity funds based on their market expectations. In the process, they miss out on some rallies.
Similarly, when the going gets tough, they panic. They try to pare down the losses by stopping further investments. It turns counterproductive – robbing them of the opportunity to buy units at lower costs.
Moreover, some investors tend to churn portfolios at short notice. A mutual fund scheme tops the charts in a year and they invest in it. And the next year, they look for the new winners. Instead of looking at long-term performance, they keep hopping in and out of funds. Such short-term orientation backfires. It’s possible that a fund manager is betting on an investment theme that is yet to gain currency in the market.
The study also found that many investors do not invest early enough and hence they see lower growth rates. Late entry into equities effectively means missing out on market growth opportunities. As market and economy evolves, it grows – but not necessarily at the same rates. Relatively larger size of economy and companies makes those heady growth rates of the past a tad difficult to replicate. This in turn tempers return expectations from the market and equity funds.
What should investors do to bridge the ‘gap’?
Focus on goals
A disciplined approach to investing can overcome emotions. Spell out your long-term financial goals and make a concrete investment plan to achieve it. Then arrive at the asset-allocation strategy – the allocation into equities, debt and cash.
Often, investors take more risk than is warranted. And it comes to the surface only when there is a market downturn. Understanding risk and especially those risks that are present in your investment portfolio could go a long way in avoiding emotional upheavals.
By automating investments periodically into funds, you benefit from building a disciplined habit. You buy more units when the market is down and less of it when market is up. It eliminates the need to time the market. Monthly SIP into a handful of equity funds over the long-term is all that is required to make the most of the equities. For periods greater than 7-10 years, equities have time and again beaten other asset classes to give inflation-beating returns.
Weed the non-performers
Also, keep track of your portfolio and regularly weed out the laggards. If a fund has consistently underperformed, redeem it. Don’t be a return chaser. Rather look at consistency and long-term fund performance. Diversify your investments by investing in a handful of top-performing funds.
Not the least, start early. Only then the power of compounding will work its wonders.
You can make enough wealth from your MF investments by staying disciplined and by focusing on your financial goals. By automating investments into equities and by starting early, your investments can grow in sync with that of the fund NAV.