As per reports, the asset management company studied the mutual fund returns generated in 20 years ending March 2022. During this period, actively managed equity funds generated returns of 19.1% per annum. But investors in such funds earned only 13.8%. It’s a huge difference, and I mean a really big one. In 20 years, 19.1% means that Rs 1 lakh will increase to Rs 33 lakh, while 13.8 per cent means just Rs 13.3 lakh. It’s a life-changing difference- like being rich vs being middle class. Similarly, hybrid funds gave returns of 12.5 per cent, but investors earned around 7.4 per cent. Again, the difference is huge. For an investment of Rs 1 lakh, it is actually Rs 10.5 lakh versus Rs 4.2 lakh. Based on my experience, this is normal.
I have always had the impression that investors earn much less than the actual returns of the fund. Why does this happen I am sure that everyone who reads this newspaper can guess the answer very well.
We investors are our own worst enemy. On one hand, we are obsessed with choosing the best mutual funds to invest in. On the other hand, we buy and sell funds at exactly the wrong time with the guarantee of reducing our returns. Result- We choose good funds and then manage to earn returns which are not better than bank fixed deposits. The behavior is quite predictable. Basically, it can be summed up as ‘buy with excitement, sell with panic’. I guess I should copyright that phrase. It has zero hits on Google so I guess I coined it!
The meaning is self-evident. People invest only when there is tremendous enthusiasm in the stock market. That is, when the prices are already sky high. Then, when there is a huge panic, when equity prices are falling and mutual fund NAVs decline, they sell. Overall, this equates to ‘buy high, sell low’, which is the exact opposite of what one should be doing. Instead of finding an optimal investment strategy, doing so puts investors in the opposite position, a ‘disappointing’ investment strategy. Note that when I am talking about mutual funds here, it is because my discussion started with an analysis done by a mutual fund company. Everything I say here applies even more to equity investors, the only difference being that a neatly packaged comparison like the one above cannot be done. In fact, what happens in stocks is the twin mistakes of selling too early and selling too late. Of course it is in different investments.
People buy a stock, and when they think it has risen as far as it is going, they sell it which reduces profit and booking profits. In fact, they fear that profits will go away, or simply decrease. The regret and embarrassment is not worth it. The feeling of success, closing a trade at a high point is very valuable to them. It’s a victory. The evil twin of this behavior is holding onto Dude Investing. In booking profits too early, investors are motivated by locking in a win. in catching a bad Investment, they are motivated not to stop in defeat. The net result is that investors sell off their winners and hold on to their losers.
At this point, I wish I could say that once investors understand the problem, they will take steps not to make these mistakes. However, investing in wrong ways whose root cause is rooted in human psychology is not easy to fix even when they are understood. Some will fix it, some won’t. This is how the human mind works.
(The writer is CEO, Value Research.)