Mutual Funds Strategy 111: Why People Switch Investments Prematurely.
The biggest drag to optimal returns is premature switching and not a wrong selection of Investment Portfolio. People usually think they made a wrong choice by investing in XYZ funds so they withdraw money to invest elsewhere. They cannot be blamed per se, there are more than 2900+ mutual fund schemes to invest in. How would they know if they made the right choice?
Mutual funds are diversified financial instruments, they always invest in a basket of stocks so that the downside impact is minimal, but what about the returns?
When you invest in a basket of stocks, the returns are capped as there will always be laggards in the basket. If you look at the top 20% of performers, it would earn more than 80% of the MF returns. Whereas the bottom 80% of stocks would have dragged the total returns down. You cannot wish away these laggards, it is part of the package.
The real problem does not stop there, an investor would have held on to a particular MF folio for 3 years and could be behind the Nifty50 index fund returns. This is where they panic and start blaming the AMC. After a while, the investor will decide enough-is-enough and switch to another mutual fund in the expectation of getting a higher return.
When you invest directly by bypassing the mutual fund distributor, this problem is prone to happen. The investor looks at the top-performing MFs every month and decides to go by that. What could happen in the next month, quarter or year is that the fund may no longer be the top-performing fund now. Going just by looking at the returns is not a good strategy.
How to address this problem? There are two options.
- Understand the investment objective and returns profile of the fund if you are a direct investor.
- Always choose a mutual fund advisor/distributor to suggest you the best investment vehicle.
Investing directly is the best option provided you know what parameters to look at. You can save 0.3% to 1% a year if you bypass a mutual fund distributor and go direct. That translates into Rs300 to Rs1000 savings for every lakh of investment.
As a direct investor, you need to look for the investment objective of the fund. What is its goal, strategy, and tactical allocation? You may get some hints by viewing the current portfolio holding and its weightage. It does not stop there, you need to check what the AMC does when the markets move and the holding companies get volatile. Comparing the weightage & allocation Month on Month and Quarter on Quarter will give you ample clues. Also, check if the AMC is removing the losers and adding on to winners or doing the opposite. Adding on to winners is usually a growth strategy. I am very sure the AMC will stay true to the label. If they are adopting a particular strategy, they will stay consistent with that.
The second best option is to hire a good mutual fund distributor who can do this for you. Due to the necessary certification requirements from the regulators, these advisors/distributors would be adequately equipped to find out what is happening.
The takeaway from this article is, do not switch the funds just because their returns are sub-optimal to the peers. Pausing new allocations to the fund is a better idea, but a redemption/transfer will attract tax loads and may not serve your best interest.
Even if the fund is a direct investment, I am quite sure any MFD will be willing to help if you ask them for advice. Asking for advice is not a sign of weakness, it’s a sign of wisdom as you are delegating the difficult part to someone else.
For comments, discussions & opinions you can reach out to me @viswaram
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Calculators are for illustrations only and do not represent actual returns.
Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.