No, the title is not incorrect.
It does seem a bit perplexing at first glance but read further and you will have your answers.
Compatibility
Best performing mutual funds may not exactly be in line with your risk profile.
In simple terms, it may not be suitable for you.
You may like a particular brand of shoe but the shoe also has to be in your size.
Let’s take the example of large cap mutual fund schemes.
A large cap fund by SEBI regulation has to keep a minimum of 80% of its portfolio in to large cap stocks.
There is no restriction with regards to the remaining 20 %, it is completely at the discretion of the fund manager so every large cap fund will have its own fund style and allocation.
Let’s take example of two large cap schemes:
Scheme | Large Cap | Mid Cap | Small Cap |
Motilal Oswal | 85.84 | 3.18 | 10.98 |
Axis Large Cap | 100 | - | - |
Based on the above category allocation it is quite obvious that Axis Large Cap fund is a far more conservative fund that Motilal Oswal Large Cap Fund.
The prior has no allocation towards mid & small cap stocks with 100% allocation towards large cap stocks.
Now if you go only by recent returns with no concern with fund management style and category allocation and if Motilal Oswal Large Cap fund has higher returns than Axis Large Cap Fund then chances are high you will choose Motilal Oswal Large Cap fund.
Such an approach is therefore very harmful to both your hard-earned money and portfolio, look beyond returns.
The best performing funds may not necessarily be the most compatible one.
Click here to read our review of Motilal Oswal Midcap Fund
Winners keep changing
Historically the top performing mutual fund in a year will be replaced by another the next year.
No one fund stays at the top forever, the top performing mutual funds keep changing.
There are several reasons for this.
A fund may be heavily concentrated on a select number of stocks which all may have done well together which resulted in a rally.
A fund may be biased towards a few sectors which might have posted decent numbers which led to an upswing.
Certain market caps do well at certain times, for eg. Small at one time, mid at one and large at another.
If you keep chasing the best performing mutual funds, you end up losing on everything.
A bird in the hand is worth two in the bush.
If an investor does not invest in the best performing mutual funds that have been doing well recently, he will feel as if he is missing out on something special.
He feels as if he’s making a mistake and others are on the right since they are investing in the fund that has been doing well recently.
This realization becomes a habitual process which results in an over bloated mutual fund portfolio since no one fund remains at the number one spot at all times.
Investing in such a case is directed more by fear rather than a goal in mind.
The cost of consistently switching
As previously mentioned, no one fund remains at the top forever.
So if you want to invest in the best performing mutual funds, you will end up switching almost every other year.
Such frequent switching come at a price though:
- Short term capital gains tax if investments are held for less than a year.
- Exit loads wherever applicable (mostly if held for less than a year).
Losing out on the compounding benefits since you never gave your investments enough time to grow and multiply.
Besides the above mentioned points, all the constant switching makes managing your portfolio a herculean task.
You are left with an over bloated portfolio that becomes difficult to track and manage and if there are newer regulatory changes like say ceasing of fresh investments into a fund that makes things only tricky.
Click here to read about Stepup SIP & why you must consider it
Keep your Expectations in check
If you’re expecting 12% returns then keep in mind that this is not going to be an annual occurrence.
The returns expectations have to be long term, over the long term that is 5 years and beyond it is reasonable to expect such average returns.
But if you are expecting such returns each passing year then you are in for major disappointment.
So many investors invest in a fund that has recently done well expecting the fund to go even higher the next year only to be left disappointed.
Equity returns are not linear, equity markets can have stay sideways for longer than expected.
So if you are execrating the recently best or top performing mutual fund to continue its rally then prepare to be disappointed.
Yes, you should have a well-diversified mutual fund portfolio but you should also diversify well within different asset classes.
Not all asset classes do well at the same time, each one them has their phase.
One can argue that equity has potential for better returns in the long run but it can also go through prolonged periods of lull.
Most retail investors withdraw in panic, therefore it is always better to diversify across different asset classes.
Instead of looking for the best performing mutual funds, diversify across different asset classes like debt, equity, fixed income instruments, etc. so you do not feel the need to chase and can instead let compounding work.
What should you do instead
Pick funds that are in line with your risk profile rather than one with the highest returns.
Understand the strategy applied by a fund and ask yourself whether you’d be comfortable with it or not.
Diversify not only within different asset classes but also within different investing styles instead of chasing the latest fad.
Do no redeem your investments unless your goals have been achieved, let time weave its magic.
For portfolio enquiries, email us with your doubts at info@themutualfundguide.com
