Don’t fret over your mutual fund scheme’s past returns

In April-May 2017, Mint had surveyed 19 financial advisers to map some of the biggest mistakes investors make (read them here and here). For the past few weeks, we have been talking to more advisers about these mistakes (read about them at: www.livemint.com/investor-mistakes). This week, we speak to D. Muthukrishnan, a Chennai-based certified financial planner, who talks about his experiences.

Chasing performance…

The past track record of a mutual fund is important, but how much should you rely on it? Muthukrishnan says that investors give too much importance to a scheme’s past returns. “Last year’s winners may not be this year’s winners,” he said. Going by the top five performers in the calendar year 2016, if you had invested in 2017, you would have been disappointed. Just two funds replicated their past performance as they came in the top five in 2017 as well. But two other funds finished in the bottom five of the pecking order. None of the top five performers of 2015 replicated their show in 2016.

…leads to churning

Muthukrishnan says that if investors pay too much attention to past performance, then there are high chances that they will sell their funds and buy newer ones based on the latter’s past performance. In other words, such investors buy and sell funds frequently, which leads to a low holding period. He added that this can be disastrous as one needs to hold on to equity funds for at least 7-10 years. “If investors keep chasing past performance, they tend to sell funds quickly and do not make enough returns,” he said.

On the flipside, isn’t a 10-year time frame a bit too long for all equity fund investments? Muthukrishnan, being a conservative planner, doesn’t think so. He recommends balanced funds (‘aggressive hybrid funds’ as per the new norm; these funds invest 65-80% in equities and the rest in debt instruments) if you wish to invest for a 6-10 year horizon. “The reason is that meeting goals is more important than returns (and hence the conservatism),” said Muthukrishnan.

Inadequate insurance

One of the first things that Muthukrishnan insists in a new client’s portfolio is adequate and correct insurance cover. A term plan is the simplest life cover that gives your nominee a sum upon your death. If you live beyond the policy term, the premium goes to the company and neither you nor your nominee gets anything. Hence, these are also the cheapest policies and the purest form of life insurance. “Most of the people who walk into my office for the first time have endowment or whole life policies where the premium is too high. Although the investor gets some money in return at the end of the policy period, the returns are meagre, as they always are in such policies,” said Muthukrishnan.

He also insists on a health insurance policy even though the client may have an insurance cover from her employer. “Job loss is a potent threat. The health insurance cover that your employer provides may be good enough till the time you have your job or your company is around, but what will happen if you were to suddenly lose your job?” asked Muthukrishnan.

Life style debts

Many of us takes loans for various reasons, to buy a car or a home or even fund a personal expense. But only a home loan cuts ice with Muthukrishnan. All other loans, according to him, are damaging to an investor’s wealth creation. “I have seen many people with credit card debt that have either ballooned already or have the potential to go out of control. We cannot start wealth creation, unless such type of debts are paid off first,” he says. Muthukrishnan also cautions investors against taking personal loans as the interest rates can be high here.

Lack of an emergency corpus

Having an emergency corpus—or expenses of about six-odd months—is necessary to sustain yourself and your immediate dependents in case you face a job loss or are just on a break from work. Most financial planners recommend an emergency corpus; the amount differs across investors and also planners. Muthukrishnan, for instance, suggests a year’s worth or two years’ worth of expenses for emergency corpus. This, he said, should include the equated monthly instalments for loans, but need not include your monthly systematic investment plan commitments. “Asset creation can take a temporary pause till you pay off your loans,” said Muthukrishnan.