There is a subtle difference between the returns earned by the fund in which you are investing, and the returns you, as an investor, earn from the fund. And no, we are not talking of tax, but of a concept relevant for understanding investments.
All experts and advisers will tell you that when you are analysing a fund and looking at historical returns as a parameter, you should not look at one-month or one-year returns for your decision. You should look at a 10- or 15-year performance. The reason is that a relatively short period of time may not reveal the true and correct picture of that investment. It may be distorted by severe market fluctuation or phases of good and bad performance by the fund manager. In other words, a long period of time is required to gauge, minus the distortions.
Now let us shift from the fund to you, the investor. If it takes a long period to realistically gauge the performance of a fund, say 10 or 15 years, why should it not be the same for you as an investor?
There is a subtle difference between the returns earned by the fund in which you are investing, and the returns you, as an investor, earn from the fund. And no, we are not talking of tax, but of a concept relevant for understanding investments.
All experts and advisers will tell you that when you are analysing a fund and looking at historical returns as a parameter, you should not look at one-month or one-year returns for your decision. You should look at a 10- or 15-year performance. The reason is that a relatively short period of time may not reveal the true and correct picture of that investment. It may be distorted by severe market fluctuation or phases of good and bad performance by the fund manager. In other words, a long period of time is required to gauge, minus the distortions.
Now let us shift from the fund to you, the investor. If it takes a long period to realistically gauge the performance of a fund, say 10 or 15 years, why should it not be the same for you as an investor?
You remain invested in the fund for say, two years and move out due to reasons such as personal cash requirements, market correction or perceived better investment opportunity.
Whatever be the reason for moving out, your returns over a shorter investment horizon depends upon the market movement over that period of time. While your returns over a longer period also is a function of market movement, market cycles play out and things even out over a long horizon. Unless there is a significant bull or bear rally at the time of your exit, for a long-held investment, the impact of current events on returns is not great. For a short horizon, during the period of time you remain invested, your returns may be higher or lower than the long-term mean of that instrument/investment vehicle.
Matter of luck
While it is a factor of the broad market movement is a significant factor in determining returns, it is also a matter of your luck, in a crude sense. In the mutual fund industry, there are funds that have completed two decades of existence, and the annualised rates of return till date are impressive.
This is due to the positive effect of compounding over a long period of time and the growth of the market along with that of the economy.
To be noted, compounding benefit is a very powerful tool in investments, but for the real benefit to play out, you need to give it substantial time.
As an example, if you hold an investment for say three years, the benefit of compounding on your returns, apart from market movement, is only so much. If you hold it for 15 years, the benefit is significant. In the context of the mutual fund data we mentioned, it shows that the number of investors who have stayed the course, from the launch of the funds or a little after launch till date, is surprisingly on the lower side. A larger number of investors have exited after say two or four years. The point here is, an investor who entered the fund sometime mid-way and exited after 2-4 years say two or four years, willwould not get the same return as we see in the annualised return data from inception till date.
So much so for the hypothesis that So, you have to stay the course to get the same returns as the long-term historical performance of a fund.
Now to understand, why does it happen? Here we have to distinguish between a contracted-return investment e.g. a bank term deposit and a market-linked investment e.g. equity oriented mutual fund scheme. The market by nature is uncertain, goes through up-and-down cycles; but as long as the fundamentals are intact, it delivers returns over a long period of time.
Nobody can predict market movement for a short period of time, and here even one year is short horizon.
Then why do people try to take advantage of market movement over for example, one or two years?
When prices are rallying, everything seems bright, and people come in with fresh money with the expectation of expecting to benefiting from the rallyit, trying what is known as ‘catching the momentum’. If you are exiting due to cash-flow requirements, that is a different issue.
However, if you are moving away from an investment which was supposed to be for long term because you think it is not giving as much return as expected, then it is better to take professional opinion from a financial adviser.
If you are moving away because there is a better investment opportunity, you have to be convinced why the new opportunity is better and that you are not trying to catch the momentum hereof the other one.
So, what should you do if you do not have a horizon of 10-20ten or twenty years? There are many multiple types of investments possible. There are defensive investments, which you can opt for, over a shorter horizon; these last a few days to a few months or a few years.
There are debt mutual fund schemes, there are bank term deposits, corporate deposits, bonds and the like. You can choose the one that suits your investment horizon.
Conclusion
In behavioural finance, the difference between investment return and investor return is known as behaviour gap, which is a perceived dynamism on the part of the investor. Equity-oriented mutual fund schemes that have completed a long period of existence and are showing attractive returns, need to be seen in perspective.
Had only a smaller percentage of investors exited, it was understandable that most people got the benefit.
Since only a miniscule portion of investors stayed the course and actually enjoyed the returns, it needs to be seen in that light. This is a lesson for other investors as well; from an overall perspective, larger numbers of investors should benefit from market movement.
Refer: https://www.thehindu.com/business/staying-the-course/article65074707.ece