With over 2500 different mutual fund schemes in the market, mutual fund investors are spoilt for choice. First-time investors, even more so, because they can build out their portfolios from scratch. But this brings the dilemma-which fund to choose?
Well, most investors prefer to invest in funds that have a record of performing well. But is this strategy effective? Should you be investing in only a selected few top-performing funds? Let’s take a look.
Why do new investors invest in top-performing funds?
Most fund investors want good returns with minimal market risks. So, it only makes sense that they choose to invest in funds that offer good returns despite market fluctuations. After all, a mutual fund that performed well previously would likely give better returns, wouldn’t it? However, fund managers say that is not the case. They, in fact, advise against investing in funds solely based on their past performance. Why? Let’s understand.
Why fund performance shouldn’t be the only factor you consider while investing
- Recency bias
New investors often fall into the recency bias trap while making new investments. This means they tend to make future predictions on fund performance based on the recent performance of funds. However, this is a losing strategy.
Because markets are in a state of constant flux, a dip in the market in the short term could easily become a high over a longer period. This makes predicting fund performance based on short-term observations more inaccurate. And if you follow through with your investing plans based on such faulty assessments, you could get lesser returns too.
- Top performers keep changing
There’s one common trend you will observe, no matter which fund performance chart you refer to. And it is that top performers have never been the same for over two consecutive years. After all, fund performance depends on how well sectors and companies do in a given period. And no sector is known to do well all the time.
For instance, we saw mutual funds from Banking and Financial themes as the top performers in the year 2016. And in 2017, small-cap funds and Infrastructure funds took the same crown.
It’s clear that you shouldn’t be relying solely on past performance to select a good fund that will offer substantial returns. Here’s what you can do instead.
Factors to consider along with fund performance while selecting a mutual fund
- Expense ratio
The fee that fund houses charge to help you manage the fund is the expense ratio. It typically includes a record-keeping fee, fund manager’s fee, etc., among other things. Keep in mind that since you will be maintaining a mutual fund for a long period, the costs will eventually add up. So, choose a company whose expense ratio is on the lower end. This way, you make substantial savings over time.
- Relative performance to the benchmark
Estimating the performance of a fund on its own can often lead you to the wrong conclusions. So always check the relative performance of your fund to the benchmark to judge if a fund is performing well.
Remember to consider the risk you are willing to take to attain your financial goals. And keep in mind that higher-risk funds have the potential to offer greater returns but are also heavily affected by market fluctuations and vice versa.
- Exit load
This is the fee you pay if you withdraw from the scheme before the specified period. The lower the load, the lower the charges upon exit, and the greater your savings.
The bottom line
Investing in top-performing mutual funds can be a futile exercise if you’re looking to get the best returns on your investments. They depend on the risks you are willing to take, the market conditions, and more.
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