The most important thing…
It is likely that as an investor, you would have earned lesser than your mutual fund’s return. A study found that an average investor in L&T Value fund earned a return of 6.9% while the fund itself delivered a return of 21.1% over past five years, ending May 2019.
Similarly, a study showed that Axis mutual fund investors generated 14.9% annualized return while the fund returned 20.7% yearly between 2003 and 2018. The investor returns are much lower than the fund returns.
Blame it on how our brain is wired. Investors find it difficult to control both greed and fear, which makes them enter and exit funds at wrong times. Most investors buy at the peak and sell at the bottom, which is actually a good time to buy because valuations are getting cheap.
Investor behavior is fickle as they start a SIP, continue for a couple of years, then discontinue or redeem the SIP, sometimes pause it, re-commence it or reinvest it later. They do this with a hope that they can time the market perfectly, but this habit erodes their returns compared to fund’s return. This gap between investors' and funds' returns disappear if they stay put with their SIP through multiple cycles of economy without letting biases influence their investing.
We follow an Economy Valuation Index to gauge how expensive Equity Market is, to decide on asset-allocation. Asset-allocation determines what proportions should be invested in Equity and Debt at a given time without second-guessing the market movements. The objective is to buy equity at a cheaper valuation and reduce exposure when the market is expensive. Asset-allocation can itself generate alpha to your portfolio as you direct your investments into Debt Funds when markets are expensive, and switch to equity funds when prices are cheaper.
Investors will be successful by following a process and not by chasing best-performing funds based on historical returns, as there are too many variables at play and it is not possible to predict the future accurately. The funds that have performed well in the past may be already overvalued and may not perform well in the next cycle.
An investor can have a simple goal-based approach where they might decide to create a corpus of Rs 1 Crore and then work backward to save Rs 10,000 a month for 20 years assuming a 12% annualized return. This will allow them to stay the course and not get dissuaded by either market volatility or switching to a better performing fund or from many other investing biases.
Do be mindful of the biases when it comes to investing and know that these may prevent us from thinking logically in money-matters. Knowing what we are likely to fail at is the first step to peaceful investing.