When we decide to invest then our first search is to find High Performing Mutual Funds. Because we want to reach our goal as fast as possible. But are they really best funds to invest?
Let us take an example of cricket. I will consider two players to give you an idea about what I am going to share with you in this post.
First cricketer is Rahul Dravid and the second one is Shahid Afridi. Both are the best batsmen. However, on whom we rely most? Is it on Dravid or Afridi? Definitely on the WALL (Dravid) because of his consistency but not on high sixes and fours of Afridi.
Rahul Dravid’s lifetime scorecard is as below.
Shahid Afridi’s lifetime scorecard is as below.
Now concentrate on average and strike rate. You notice that the average is high for Rahul Dravid. However, strike rate is high for Shahid Afridi.
The probability of Afridi getting runs of around 23 (in ODIs) or 36 (in Tests) is high than Rahul Dravid reaching his average of 39 (in ODIs) or 52 (in Tests).
However, on whom we rely the most? It is on Dravid because of higher consistency than Afridi’s inconsistency.
You notice one more thing between these two players ODI records. Afridi played the higher number of matches than Dravid. However, he failed to attain or cross Dravid’s average.
How we connect this to equity mutual fund investments or for any investments?
High Performing Mutual Funds – How they can kill your wealth?
Let us say, two friends, Mr.Ajay and Mr.Sanjay decided to invest in equity mutual funds. They searched and found two funds are really high rated. Let us say these two funds as Fund ABC and Fund XYZ.
However, they again found that both funds average returns over 5 years are same. Now they really in a confused mind of which one to choose.
Both are high performing mutual funds and both are ranking highly in all rating portals. Also, the average 5 years returns are almost same.
In such a situation, which one to choose?
Here come the Dravid and Afridi example. Who performed consistently with lowest ups and downs? This is also be called Standard Deviation.
What do you mean by Standard Deviation?
Standard deviation is nothing but how much funds deviates from the average. I will explain you how the volatility or standard deviation will really affect your returns from below example.
I have chosen two funds named as Fund ABC and Fund XYZ. I will take 5 years average returns of both the funds, Both funds gave us the average returns of 12%. However, the standard deviation of Fund ABC is 21 and Fund XYZ is 12.
I will invest Rs.100 as a lump sum in both the funds on the same day and wait for 5 years. The results will be as below!
Average Returns are same and invested amount is also same. But the final returns are different. It is all because of volatility in the Fund ABC and Fund XYZ. That also for 5 years and for the invested lump sum amount of Rs.100, the difference at the end is Rs.5!
Many of us just concentrate on rate of return. However, ignore the biggest culprit called volatility or Standard Deviation. The results will astonishing or shock you at the end.
Why we consider High Performing Mutual Funds?
It is human tendency to look for BEST while buying something or investing. So obviously we go in search for BEST or high performing mutual funds.
We feel that high performing mutual funds will give us high returns. It is not true at all with the above examples of cricket players and the funds.
Also, we never estimate the risk we can take. We always feel that HIGH RISK means HIGH RETURN. But forget the simple logic that HIGH RISK will not GUARANTEE you HIGH RETURN. Instead, the high risk may lead to a positive or negative return, which does not mean HIGH RETURN.
The basic problem is star ratings of few online portals. However, we never try to understand of what method they adopted or in what way they are giving 5 or 4 star.
Moral-Never chase the high performing funds. Along with higher returns, how the fund generated that much high return is also important. Remember one thing, give the equal importance go goal as well as to the way of reaching goal.
Consistency is key rather than high performance. Refer few of my latest blog posts related to Mutual Funds.
- Top 5 Best Liquid Mutual Funds in India in 2017
- Top and Best Debt Mutual Funds in India for 2017
- Top 10 Best SIP Mutual Funds to invest in India in 2017
- Top 5 Best ELSS Tax Saving Mutual Funds to invest in 2017