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Sachin, Shikhar aur Mutual Fund returns

Over the last 8-10 years of advising people on mutual fund investments, my experience has been that returns from mutual funds are often
a) Wrongly Calculated
b) Wrongly Interpreted
c) Wrongly Applied

Let us get a 'firm' grip on this, if we don't want the best mutual funds to slip through our 'slippery' fingers.

A. Wrong CALCULATION
Let's take the following example of a typical SIP by a mutual fund investor:

Date
Amount
NAV
Units
Jan 1
5000
215.84
23.17
Feb 1
5000
197.30
25.34
Mar 1
5000
193.87
25.79
Apr 1
5000
184.10
27.16
May 1
5000
197.59
25.31
Jun 1
5000
187.95
26.60
Jul 1
5000
175.71
28.46
Aug 1
5000
200.12
24.99
Sep 1
5000
197.57
25.31
Oct 1
5000
199.32
25.09
Nov 1
5000
193.41
25.85
Dec 1
5000
191.28
26.14

Thus, the total amount invested is Rs.60,000; and the total units allotted add up to 309.19.

On Dec 31 the NAV is 202.236. The value of investment, therefore, works out to Rs.62,530; thereby giving a profit of Rs.2,530.

Now, most mutual fund investors would calculate their returns as Rs.2,530 / Rs.60,000 = 4.22%.

This is WRONG.

mutual-fund-returns
Are your applying the right formula to calculate your MF returns?
Why...
... because it does NOT account for the "number of days" of each investment.

Entire Rs.60,000 is not invested on a single date, but spread across many months. The first Rs.5000 has been invested for 1 year. Whereas the last Rs.5,000 only for a month.  

Therefore, here we cannot simply divide our profits by the invested amount to calculate our returns.

Rather, we have to use the Weighted Avg. No. of Days methodology, as explained in my blog post Simple Trick To Calculate SIP Returns In Excel.

Based on the same, the CORRECT returns of the above investment works out to 7.79%.

B. Wrong COMPARISON
A typical mutual fund investor would have many schemes in his portfolio. 

Typically, at the end of a given period, he will look at his portfolio and often comment... Oh! Fund C had performed badly giving only 6.50% returns. Fund E is the best with 18.30% returns. I think I should sell Fund C and move to Fund E.

Let us assume that the returns have been calculated correctly, using the Weighted Avg. No. of Days methodology.

Even then, the above comparison between Fund C and E, is (most probably) WRONG.


mutual-fund-comparison
Are your correctly comparing your mutual funds?
Why...
... (most probably) the investment in Fund C and E would have started in different months, may be even different years.
... (and often) the SIP dates in Fund C and E would be different.
... (and last but not the least) Fund C may be a large-cap fund while Fund E a mid-cap fund.

You cannot compare the average runs scored by Sachin Tendulkar who played for 20+ years, with Shikar Dhawan's average who has played for just 3-4 years. You cannot compare the batting average of Sachin Tendulkar with Zaheer Khan's.

Similarly...
when the investment dates of different funds in your portfolio are different...
when they belong to a completely different category...
... it is wrong to "compare" their returns by simply looking at your portfolio.

No. To check whether a particular fund is an under-performer or not, you don’t have to look at "your" portfolio returns.

Rather, independent of your portfolio, you have to see in general how each fund is doing in comparison to its benchmark and the peers in its specific category.

This is the CORRECT approach to distinguish between good and bad performers.

C. Wrong APPLICATION
Let's for the moment assume that everything (investment dates, category, etc.) is same for Fund C and E.

Even then, to make the statement that I will sell Fund C and move to E, is wrong.

Why...
... because you are looking at only the handful of funds that you own.

You are not looking at the entire universe. You are looking at just one TINY galaxy and saying this star is the brightest. What about the stars in the other galaxies? 

There are numerous other mutual funds that do not figure in your portfolio.  Maybe they are doing much better than even your Fund E. Therefore, wouldn't it be more sensible to switch to these funds, rather than blindly switching to Fund E. Right?

Don't let the wrong calculations and wrong interpretations, of mutual fund returns, cause serious damage to your portfolio.

CAUTION
Always compare (a) the long term performance and (b) across different periods. Sometimes, funds may under-perform in the near term because the fund manager is building a value-based portfolio, which may bear juicy fruits over long term.

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