A mutual fund’s strong past performance does not necessarily mean that an investor will earn the same return from it. The timing of investments, withdrawals, SIPs and investor behaviour can create a wide gap between a fund’s reported return and the actual return earned by an investor.
Pratibha Girish, Founder of Finwise, and Mohit Gang, CEO of Moneyfront, discussed the gap between fund returns and the returns actually earned by investors on Zee Business’ Money Guru show.
Experts said investors often look at a fund’s CAGR and assume that the same return will show up in their portfolios. However, the return earned by an individual depends not only on the fund’s performance but also on when and how the investor puts money into it.
Fund return vs investor return
A fund’s reported return generally measures its performance between two specific dates. An investor, however, may enter the fund at a different time, invest through SIPs, add lump-sum investments or withdraw money during the investment period.
As a result, two investors in the same fund can have very different returns.
The discussion highlighted the example of small-cap funds, where the category delivered a CAGR of around 14.8 per cent between March 2013 and June 2020. However, the money-weighted return for investors during the same period was around minus 1.6 per cent.
This gap was largely linked to the timing of investments. A large amount of money entered small-cap funds after the category had already seen a strong rally. Investors who entered closer to the peak were subsequently affected when the market corrected.
FOMO can hurt returns
Experts said investors often chase funds, sectors or asset classes after seeing strong past returns.
When a trend becomes popular, investors may fear missing out and enter after a large part of the rally has already taken place. This can result in buying at expensive valuations and lower returns in the following years.
The discussion also pointed to examples involving gold, silver and other sectors where investors entered after strong rallies because they expected the trend to continue.
Experts advised investors not to make investment decisions only on the basis of the previous six months or one year’s performance. Instead, they should consider whether the fund fits their financial goals, portfolio allocation and investment horizon.
Discipline matters
Investors should avoid desperate moves like fund switching, as it can also reduce investor returns with taxes, exit loads and other costs added up in the activity. SIP plays a critical role in investment while making investors determined and disciplined. If an investor stops a SIP at the wrong time, it can affect the final return.
Experts stressed that investors should research a fund before investing and have a clear idea of the role it will play in their portfolio.
Staying invested and continuing the SIP during the downtime will help investors to average out the NAVs of their mutual funds, which means they will get a higher return in the long-term.
For investors, staying invested with patience and avoiding panic selling or FOMO-based decisions can help narrow the gap between a fund’s reported performance and the actual returns.