How to get better returns from your mutual fund portfolio

As we embark on a new decade, it may be interesting to see how our stock market did in the last decade (2010 to 2020). In the last decade, Nifty 50 TRI gave 10.2% CAGR returns. As far as the broader market was concerned, the Nifty Midcap 150 TRI gave nearly 12% CAGR returns in the last decade. Equity as an asset class outperformed all other asset classes which were traditionally favoured by Indian investors i.e. fixed income and gold by a big margin.

Further, mutual funds were able to create alphas for most investors. For example, midcap funds category average CAGR returns beat Nifty Midcap 150 TRI CAGR by 1.25% in the last 10 years, while large cap funds category average CAGR returns beat Nifty 50 TRI CAGR by 0.7%. While the last decade has showcased the wealth creation potential of mutual funds in the long term, many investors were not able to maximize this potential due to improper planning and faulty decisions. In this blog post, we will share some thoughts on how you can maximize returns from your mutual fund investments.

Understand risk / return trade-off

Risk / return trade-off is one of the most fundamental relationships in finance, which all investors must understand in order to take informed investment decisions. You need to take more risks to get higher returns and have a long investment horizon for the risk / return trade-off to play out. Equity markets always work in cycles (bull and bear markets) and if you have a long investment horizon then you will definitely give your investment a chance to recover from corrections and generate wealth for you.

Invest based on risk profile and financial goals

Investors should consider their ability to take risk to get potentially high returns from their investments.Different asset classes have different risk profiles. Fixed income has low to moderately low risk profile, while equity has moderately high to high risk profiles. You should diversify your investments across different asset classes, depending on your different financial objectives / goals. For your short term goals e.g. saving for a foreign vacation, saving to make down payment for house purchase etc, you should invest in low risk assets e.g. debt funds. For your long term goals e.g. retirement planning, children’s education etc. you can invest in assets which have moderately high to high risk profiles e.g. hybrid funds, equity funds etc. You should always invest according to your financial goals.

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Diversify your investments

Different asset categories outperform or underperform each other during different periods. For example, in the last 2 years (2018 to 2020), the broad stock market (Nifty 500 TRI) gave less than 4% CAGR returns, while gold gave 14% CAGR returns. In the preceding 3 years (2015 to 2018), Nifty 500 TRI gave around 13% CAGR returns, while gold gave just 3% CAGR returns. During the last 5 year period traditional fixed income investment options gave 6.6 to 7.3% CAGR returns over 2 – 3 year investment tenures (debt mutual funds gave average 6.8 to 8% CAGR returns). It should be evident that if you diversified your investments across different asset categories then you would have given your portfolio much greater stability to your portfolio across different market conditions. Diversification helps to create a hedge against uncertainties and also in benefiting from the returns of different assets.

Suggested reading: Importance of diversification in financial planning

Follow a blended investment strategy

Basically, there are two styles of investing: lump sum investing and systematic Investing or SIPs. Seasoned investors who understand equity markets or those with very long term investment horizon may opt for lump sum investments while new investors or those who have investible surplus every month post meeting necessary expenses can ideally invest through SIPs. Even though they both have disparate styles but they have their unique benefits, if done correctly. An investor can purchase units at low prices by timing purchases when markets are low with the strategy of lump sum investments.

Alternately investors can make investments in a regular manner without worrying about the need to time the market. Additionally, there is also the benefit of compounding and rupee cost averaging in SIPs. Investors can choose their style keeping their financial goals in mind and to maximize their returns. They can decide on the allocation into different styles as well as how much to invest through each route based on their unique investment requirements. In our view, SIP is the best mode of investing in multi-cap, midcap and small cap funds. In volatile markets, investors may also keep some money aside (preferably in liquid funds) to tactically invest in lump sum during deep corrections.

Read about Mutual Fund SIPs and Power of Compounding and also can you get higher returns by spreading your mutual fund SIPs across multiple dates

When investors receive one-time cash flows like annual bonus / incentive, maturity proceeds of FD or life insurance policies, sales proceeds from property, they often keep the money in their savings bank account (earning just 4% interest) or lock it up in FDs at lower interest rates. Debt mutual funds are much better options for deploying your idle funds to productive use and earning higher returns, till you figure out how to invest these funds for the long term.

Use smart investment options like STP and SWP to enhance your returns

In volatile markets, investors often stay in cash in order to feel confident about market recovery before they invest. However, given the volatile nature of our market, the bounce-back rallies from market bottoms are often very strong and investors miss out on opportunities of investing at low prices by delaying their investment by a few months or a year. Mutual funds offer investors the option of using Systematic Transfer Plan (STP) to take advantage of volatility. Investors can transfer a fixed amount from one scheme to another at a regular frequency.

For example - if an investor wants to invest in an equity fund but is worried that the market may fall in the next 6 months, he / she can invest in a low risk / no load liquid fund and transfer money at regular intervals (weekly, fortnightly, monthly etc) to the equity fund. STP will ensure rupee cost averaging of purchase price along with liquid fund returns for the investor.

Did you know how mutual fund STPs can help invest in volatile markets

Systematic Withdrawal Plan (SWP) gives investors the flexibility to draw the amount they need from their mutual fund investments at a regular frequency (e.g. monthly). The balance amount remains invested in the scheme and continues to earn returns for the investor. Unlike mutual fund dividends, which have to be paid from the profits made by the scheme and therefore cannot be assured, investors can get fixed cash-flows using SWP. For investors in the higher tax brackets, SWP is also much more tax efficient than traditional fixed income options. Budget 2020 proposals make a stronger case for SWP, because in SWP capital gains in equity oriented funds will be taxed at 10%, whereas mutual fund dividends will be taxed as per the income tax slab rate of the investor.

Suggested reading – Mutual Fund SWP: Smart investment solution for cash flow needs and wealth creation

Periodically check your returns

It is important for an investor to understand that building a robust diversified investment portfolio is not a one-time activity and an investor should continuously monitor his / her portfolio performance at a scheme level and portfolio level. Some financial advisors review portfolio performance with investors on a quarterly basis. If you do not have time to review your portfolio every quarter, an annual portfolio review will also suffice. Very often investors keep underperforming schemes in their portfolio for very long which harms their financial interest. If your scheme has underperformed you should try to understand whether the underperformance is temporary caused by market factors. No action is required in such cases. However, if a scheme continues to underperform versus its benchmark index for a period of time, then you should replace it with a better performing scheme. Investment experts suggest you should have an evaluation period of at least 3 years for equity funds.

Conclusion

Investors can accomplish their goals of earning high-yielding returns on their investments by opting for a disciplined investment approach suiting their respective risk profiles. People should understand that mutual fund investments are market-linked and there is no certainty when it comes to markets. However, by making adequate efforts to implement the above suggestions and investing according to a financial plan, an investor will be better placed to maximize the returns from mutual funds. Investing can be a confusing game for many who do not have sufficient experience and some hand-holding may be required for you to make the right investment decisions. Therefore, we always suggest that you should consult with a financial advisor if in any doubt, instead of trying / guess what will work out to be the best for you.