How investor behaviour can ruin returns from your fund
Has it ever happened to you that your mutual fund scheme returned 20% but you only made 10% out of it? Ideally, investors should get the same return as the fund, minus the costs. But often that’s not the case. An investor’s behaviour plays a key role here. Let’s look at how investor behaviour can spoil the returns, and ways to avoid the pitfalls.
Problem of averages
We tend to get drawn by the average number that we kind of expect to be the norm. We forget the path that the fund had taken, its highs and lows, and just focus on the average.
Three funds that give a compounded annualized growth return of 15% in the same time period of 5 years, could take very different trajectories (see graphic). We have assumed Scheme A is least volatile, scheme B is more volatile and scheme C is the most volatile of the three. More importantly, none of the schemes gave 15% return in any year.
Solution: Averages are a good indication but understand that funds can swing wildly. In other words, understand the risk that the scheme can take.
It’s one thing to say that you can stomach the volatility. But it’s quite another to actually see it. In volatile times, fund houses tell us that redemptions go up and systematic investment plans (SIPs) tend to stop, albeit prematurely. Behavioural experts say that investors feel the pain of loss twice than the happiness they derive when their investments do well. This is called loss aversion. For instance, financial planners tell us that when equity markets crashed in 2008 the world over, including in India, not many SIPs closed prematurely, but in 2013, a lot of them closed when investors saw negative returns for 5 years, until that point.
Solution: Markets—equity or debt—can be volatile. The key is to understand why they are falling. If your mutual funds fall because of market-related conditions or external factors, but your fund’s strategy is in place, hold on. But if your fund’s strategy has gone wrong, talk to your financial advisor to understand if it’s a temporary blip.
Imagine the equity market falls by 1,000 points. Next day it falls again by another 500 points. Your neighbour says she is selling her equities. Then, you hear your office colleagues saying they are selling too. What do you do? If you sell your equity funds as well, you’re simply following the herd, without any logic.
Solution: In reality, you should be buying more equities when markets fall, opportunistically. Last year, Mint published a Mint-Crisil Research study that showed that in order to get the most out of your SIPs, you need to continue your SIPs for at least six years to drastically lower the probability of losing money.
Don’t follow the herd, but ensure you are on course to meet your goals and keep your asset allocation in check.