Why Mutual Fund Investors Should Tone Down Their Return Expectations
Jan 15, 2018

Author: PersonalFN Content & Research Team

Returns Expectation

When the market is at record highs, returns over multiple periods look extraordinary.

The 1-year, 3-year and 5-year returns of the S&P BSE 200 index as on January 12, 2018 works out to 31%, 12%, and 14% respectively.

The top mutual funds delivered returns in excess of 40%-50% in the 1-year periods. Over 15%-20% compounded in the 3-year periods and above 20% compounded in the 5-year periods.

Looks impressive, but can you expect the same kind of returns from mutual funds over the next 1-year, 3-year and 5-years?

Many nascent investors expect to achieve this kind of returns in just three to five years. If you are expecting to achieve double-digit returns from mutual funds within this time-frame, you may be in for a rude shock.

What most investors overlook and what most advisors fail to highlight, in layman terms, is the probability of scoring mediocre returns or suffering even a loss of capital.

For those whom investing is not a profession, price risk measured in terms of volatility, standard deviation or other risk metrics, will seem like Greek and Latin.

So let us take a look at volatility from a different perspective.

How often has the stock market returns over a particular period actually aligned itself with the long-term average?

PersonalFN takes a look at the data for the S&P BSE 200. Most equity diversified mutual funds benchmark their performance against this index. Hence, the insights from this analysis will be applicable for mutual funds across the board.

The study reveals that the long-term average return of the S&P BSE 200 is 14% compounded annualised over a 20-year period.

1-Year Returns of S&P BSE 200

Returns in percentage. Data as on December 31, 2017
(Source: ACE MF, PersonalFN Research)

On viewing the returns based on 1-year periods taken at a periodicity of every three months, the volatility is clearly visible in the chart above. But what’s more revealing is that the S&P BSE 200 was able to return over 14% only on 42 occasions or 53% of the time. In as many as 22 occasions of one-year period, the index delivered a negative return.

We conduct a similar study for 3-year and 5-year periods. For the 3-year periods, there were just 32 occasions or 40% of the time when the index generated a return in excess of 14%. The index dipped in to the red on as many as 13 occasions or 16% of the time. The statistics for investors improved in the 5-year periods. The index delivered a return above 14% on 33% of the 5-year periods, while providing a negative return on just 10% of the times.

Clearly, increasing your investment horizon can move you closer to the long-term average return mark. But more importantly, the volatility in returns reduces. The chance of you losing capital shrinks.

Hence, when investing, don’t get carried away with the supernormal returns of the market. Tone down your expectations on return and always invest for the long term.

To conclude…

When it comes to picking the right mutual fund schemes, you need to be extra cautious in an euphoric market. As the saying goes, a rising tide lifts all boats, similarly, in a bull market, even the worst performing mutual funds deliver double-digit returns.

Hence, investors should prudently pick schemes after comparing the performance with the benchmark and other similar schemes. More importantly, investors need to remain patient and focused on their long term goals.

Staying the course with mutual funds is easy in periods of above average market returns. We are in such a period right now. But, when faced with periods of disappointing returns, it may test an investor’s faith in the equity markets.

Being aware of the potential outcomes can help you remain disciplined. This in the long term can increase the odds of a successful investment experience.

How should you deal with the ups and downs of the market? While there is no straight solution, one of the best ways to deal with market volatility, is to invest in mutual funds via a Systematic Investment Plan and yes, keep a long-term focus. Setting the right asset allocation will help align your risk tolerance with your investment goals.

SIP is only a method of investing in mutual funds. To support this investment method, you also need to pick the right mutual funds. PersonalFN offers a report titled "The Super Investment Portfolio – For SIP Investors."

After a rigorous shortlisting process, PersonalFN goes a step ahead to select funds that are SIP-worthy. Under this, PersonalFN conducts a detailed analysis on how SIPs in the top shortlisted funds have performed across multiple market conditions and timeframes. Only those funds that successfully pass this evaluation are suggested.

You can read more about the report and the subscription details here: The Super Investment Portfolio – For SIP Investors. Don’t miss out on special discounts. Subscribe Now!

Try our SIP Calculator to find future value of your SIP contributions.

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Jan 19, 2018


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