A Proximate Cause: Your Investment is Probably Underperforming

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Equity markets are volatile, and by their very nature, can deliver inconsistent returns. While this cannot be entirely avoided, it can be helpful to zero in on possible reasons that may be causing your investments to underperform. Identifying these factors and protecting yourself from them can give a significant boost to the returns you generate on your investments. From avoiding over-diversification, to picking a direct mutual fund platform, there’s plenty an investor can do to maximize the gains on their investment.

A Proximate Cause Your Investment is Probably Underperforming

Of course, it’s important to know what factors may be at play here. Here are some of the possible causes your investments may be underperforming, and what you can do to avoid such a scenario.

 

#1 Over Diversification

Diversification is a golden rule for investments. In fact, mutual funds are highly recommended as an investment option primarily because they are diversified holdings which significantly reduce your risk exposure. But excessive diversification can come with its own set of challenges. Some mutual fund schemes can ‘overdivesify’ i.e. the can have positions in too many stocks. The more this number, the closer you may be getting to the market’s average performance – in which case you may as well have invested in an index fund, right? Avoid mutual funds that are too diversified.

Another factor to keep in mind is to research and invest into select mutual funds that can align with your investment goals. If you’re investing in too many mutual funds, the low performing ones negatively impact the returns the top performing ones may be bringing to you. So it’s better to understand where and how to start.

 

#2 Capital Gains Taxes & Other Charges

Any redemption of mutual funds within one year of purchase attracts a capital gains tax of 15% on the gains. The capital gains tax falls to 10% if you redeem beyond one year of purchase, so you stand to save on 5% of your returns if you hold on for longer periods. Many mutual funds also charge an ‘exit load’ of 1% on your holdings if you exit within certain periods – such as 6 months or 1 year. This too can be avoided by holding to your investments for longer, saving a valuable part of your returns.

 

#3 Regular Mutual Funds vs Direct Mutual Funds

Another important reason for a lower performance on your investment may be your choice of a mutual fund platform. Picking a direct mutual fund platform can add to your returns by a significant amount in the long run. Mutual fund schemes typically have 2 variants – a regular mutual fund and a direct mutual fund. Regular mutual funds have a larger expense ratio – by virtue of them having to pay a commission to their brokers on your investment. This value can be anywhere between 0.75-1 percent, or higher. A direct mutual fund platform helps avoid these charges, which translates into higher returns for you.

 

#4 Investing In a Lump Sum Instead Of Via A SIP

A Systematic Investment Plan is a highly recommended way to be performing your investments. It involves investing small amounts at fixed intervals – whether there’s monthly, quarterly or even every 6 months.

Thanks to the concept of rupee cost averaging that a Systematic Investment Plan brings with itself, your cost of investment is reduced. This leaves more room for gains. This would not be possible if you were investing via a lump sum amount since you’d either be investing at higher levels, or you’d spend too much time and energy trying to ‘time’ the market – both of which are entirely avoidable with a SIP. A SIP is an ideal way to build wealth over the long term.

A SIP can be initiated in most mutual funds with amounts as low as Rs.5000 and can be customized to your needs and goals. It also leaves a large amount of your investment corpus with you, which you can choose to invest at later stages separately as well if market conditions are inviting.

 

#5 Lack of Research/Poor Research When Picking Mutual Funds

Lack of Research - Poor Research When Picking Mutual Funds

While it is important to pick a direct mutual fund over a regular mutual fund, it’s also equally important to pick the right mutual fund in the first place. A lot of factors are at play here – from the funds past record to its mutual fund manager, the sector/equities it is invested in, and more. Lack of appropriate research can lead to poor results, even if you’ve picked your funds from a direct mutual fund platform.

When selecting your mutual fund, make sure it aligns with your investment goals. Is it invested in the equities you are confident about? How is it performing compared to other funds of its category, and sector? Who is the fund manager and what is his past record? A well-informed decision can go a long way in avoiding unnecessary stress.

 

#6 Market Conditions vs Expectations

Sometimes the markets can be going through a bearish phase across all sectors, leading to poor performance for all mutual funds. In such cases, it is important to look at your mutual fund’s performance relative to other mutual funds. This is likely to give you a more accurate picture of the scenario.

In fact, a SIP can prove useful in such scenarios as well. During a bearish market, a SIP will reduce your average cost again.

Sometimes, underperformance can be the result of unrealistic expectations. It can be unreasonable to expect a mutual fund, which may have delivered 40% returns last year, to deliver the same performance for the next few years. The equity markets are volatile, and consequently, so are mutual funds. Some sectors may do well during certain seasons or for certain years, while others may take their place later. Tailoring your expectations to make them more realistic, along with a dose of patience can come in handy here.

That being said, there are always some factors you can control and influence and some that you can’t. It is in your hands as an investor to pick a direct mutual fund platform, avoid exit loads, and even start a SIP. While market conditions cannot be changed, they can be taken advantage of. As an investor, it is important to remain well informed and take well-thought decisions.

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