The lure of potentially high returns from investments in Mutual Funds is a popular reason why many investors choose Mutual Funds to build long-term wealth.
Investing in Mutual Funds is considered safer than investing directly in the stock markets and is invariably more rewarding than investing in traditional investment instruments such as Fixed Deposits and Recurring Deposits.
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However, investors must be prepared to expect a certain degree of volatility in the returns generated by Mutual Funds. Since some types of Mutual Funds are linked to the equity markets, they may not always generate high returns. There may be a few low spells for investors every now and then.
But, if investors are not ready to wait out the storm and be patient, it will defeat the purpose of long-term investments in Mutual Funds.
BB Tip: It is a good idea to remain invested in Mutual Funds for the long-term if you want to see consistent returns from your investments.
Don’t panic when Mutual Funds tank
We understand it is common for investors to initially hit the panic button when their Mutual Funds’ performance takes a hit because of a bear market. One of the secrets to successful investing is not to panic in case of short-term market fluctuations. We can help you understand what you must ideally do when you find your Mutual Funds underperforming.
We will begin by telling you how you can analyse a Mutual Fund’s performance.
Performance analysis
There are two main stages of wealth creation with investments in Mutual Funds. The first is making regular investments and the second is periodically reviewing your investments at regular intervals. For investing success, investors should not forget to analyse their fund’s performance from time to time.
Keeping an eye on the fund performance helps you to better diversify your investments and to take advantage of market volatility, rather than lose out to a bear market. Realigning your asset allocation on your investments will help minimise the effects of market volatility on your investments.
Additional Reading: Intelligent Asset Allocation
You can assess your fund’s performance by breaking down the returns generated over the past eight to twelve quarters and benchmarking the returns against the performance of the index.
To assess your Mutual Fund’s performance, you can also compare the performance with that of other funds in the same category.
If your Mutual Fund is underperforming in comparison to the index benchmark, once in four to six quarters, you could choose to remain invested, rather than pulling out your investment.
However, if the fund has underperformed consistently for more than three to four quarters at a stretch, then your Mutual Fund is definitely an underperformer. It may be in your best interest to exit the fund as soon as possible.
Additional Reading: 4 Ways To Evaluate A Mutual Fund
What are the possible reasons for an underperforming fund?
Once you notice an underperformance in the Mutual Funds you have invested in, what you must do next is identify the reasons for the underperformance.
Here are a few important reasons for a Mutual Fund’s underperformance.
Change of fund manager
Every Mutual Fund manager has an individual style of managing an investor’s investment portfolio and the larger Mutual Fund’s portfolio. The fund manager’s decisions on asset allocation have a direct impact on the fund’s overall performance. A change in the manager, therefore, will greatly affect the performance of the fund on a positive or negative scale, depending on the successive manager’s management style.
Additional Reading: Importance Of A Good Fund Manager
Acquisition or merger of the Mutual Fund
In case the Mutual Fund was acquired by or merged with another Mutual Fund house or another Mutual Fund, investors will notice an impact on the overall performance of the fund. Such a merger or acquisition will result in a change in the fund manager, leading to a change in the fund’s investment style. A merger or acquisition could also influence investors to stop investing or exit from the fund completely.
Style of management of the fund
The manner in which a Mutual Fund is managed can also be a valid reason for any underperformance. Aggressive fund management practices may deliver returns in a bull market. Funds which follow a contrarian investing style or a value investing model could underperform during a rallying market, especially for funds that focus on growth stocks.
Read This: How Mutual Funds Work
Expense Ratio
Expense Ratio is the charge levied on each unit of the fund bought by investors. All Mutual Funds incur different costs in order to manage investments. These costs are charged against the Assets Under Management (AUM). An Expense Ratio can vary between 1.25 – 3%.
To put it in simple terms, the higher the Expense Ratio of your Mutual Fund, the lower your return will be, because the returns on your investment decrease in proportion to the value of the Expense Ratio. You must choose to invest in Mutual Funds that have no sales load or Expense Ratio, to enjoy higher returns.
How to deal with underperformance
A buy and hold strategy does not always work with Mutual Fund investments. In some investment scenarios, it becomes necessary to exit a fund if there has been a long period of consistently poor performance in terms of the returns generated.
Additional Reading: The Right Time To Redeem Your Mutual Fund
Switch funds
Don’t hesitate to exit the underperforming Mutual Fund if it has recorded poor returns repeatedly over the past three years. Redeem your investments in any Sectoral Funds because you must keep in mind that Sectoral Funds take much longer to recover from a market slump.
Hold funds
If on assessment of your Mutual Fund you feel that the fund will probably recover and deliver better returns in future, you can choose to remain invested and ride out the rough patch.
If a Mutual Fund is managed by a fund manager who displays insightful, impactful and a largely positive management style, you can be assured that the fund will report positive returns in the long run, even though there may be some intermittent volatility over a short or medium investment term.
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Now that you know how to deal with underperformance in Mutual Funds, make an informed decision with your investments.