Why mutual fund investors make lower returns than the funds they invest in

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Most mutual fund investors tend to make lower returns than the schemes they invest in, finds a study.

Investors tend to invest based on market movements, which leads to lower returns, compared with the funds they invest in, the Axis Mutual Fund study found.

The fund house conducted the study across three fund categories—equity, hybrid (or multi assets) and debt funds—and used 2004-20 data for equity and hybrid funds, and 2009-20 data for debt funds.

The study found “investor flows are not stable but tend to follow market performance. As a result, realized returns are much worse than they would have achieved by using either simple ‘buy’ and ‘hold’ or systematic investment strategies. This effect is persistent across periods,” according to the study.

As investors tracked stock market performance, their returns are consistently lower than fund returns across different periods. The lesson: Investors need to stay disciplined and focused on the long term, irrespective of market volatility.

According to the study, four behavioral traits affect investors’ returns:

  1. They overreact to market sentiment
  2. They focus too much on short-term market or fund performance
  3. They don’t follow asset allocation strategy
  4. And, finally, they tend to invest haphazardly, rather than systematically.

The best example of these mistakes is 2020, the year the market saw high volatility due to the covid-19 pandemic.

“As we have seen repeatedly over multiple market cycles, sharp falls in market have a large effect on investor flows, and the same was seen this year as well, especially for equity funds,” the report said.

From being strongly positive, investor flows into equity turned negative in the second half of 2020 as the impact of the market correction played out.

There was also a significant drop in systematic investment plans (SIP) as many investors didn’t renew them or cancelled ongoing SIPs.

Here are investors’ returns compared to funds’:

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Investors’ returns compared to funds’ performance

The study also suggests best strategies for mutual fund investors, including starting early to get the benefit of compounding, and having an asset allocation strategy.

Market movements should not affect frequency of investment and, when investing in equities, have a long term horizon, the study said.

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