What you see is not what you get
Fund returns and fund-holder returns are often different. There are various reasons. Returns are point-to-point so if your entry was wrong, returns could be drastically different. If you are invested in the wrong funds within the category, returns will be lower than the category average. Lastly, there are other factors that eat into your returns like entry loads, exit loads, STT and taxes. Here are 10 ways to improve returns on MF investments.
Step 1: Stick to consistent winners over time
Past performance may not be a guarantee of future returns, but it is surely indicative. Funds that have done consistently on 3-year and 5-year CAGR basis, have a story. It is very unlikely that such funds suddenly start to underperform. Avoid funds with very low AUMs since that can be a reason for liquidity risk. Generally, long-term leaders are consistent over time.
Step 2: For self-driven investors, Direct Plans work best
Direct Plans give higher returns because they don’t bill the marketing and other costs to the investor NAV. In a typical equity fund, Direct Plans give around 1% to 1.5% better returns than a regular plan. Unless you need absolute handholding in mutual fund investing, look for Direct Plans. Saving 1% to 1.5% annually over 20 years makes a big difference.
Step 3: Passive funds score with lower expense ratios
In the last 3 years, as per an ACE MF study, 70% of equity funds underperformed the index. There are reasons like kurtosis, liquidity etc. If you opt for an index fund or index ETF, you can take exposure to large cap stocks with low expense ratio. This is a profitable strategy. Investors can take part of their exposure to large caps via index funds to enhance returns.
Step 4: Spread your MF investments to spread you risk
If you thought diversifying reduces returns, think again! If you are entirely in equities and if the index falls by 40% or if you are entirely in debt and the interest rates spike by 3%; you are in deep trouble. Spreading mutual fund investments is not just about risk but also about returns. Over a time-frame of 5-7 years, diversified portfolios work a whole lot better.
Step 5: SIPs help you realize better value over time
Most studies confirm that timing the market is impossible even for the most battle-hardened experts. Most investors should not even try that. The problem with lump-sum investing is that even if you get a few bad days of purchases, returns can be negative. A better way is a SIP where rupee cost averaging reduces cost and enhances returns.
Step 6: Keep a bullet plan ready
What is a bullet plan? It is a fixed amount you invest in a liquid fund as a back-up. Then you create a rule that each time the index corrects 10%, you move part of this money into equity funds. Your SIPs will continue as usual, but if you add this bullet idea to the SIPs, it can help you buy lower. This tends to enhance your long term returns on mutual funds.
Step 7: Plan your exit to maximize post-tax returns
At the end of the day, you earn returns post-tax. Capital gains above Rs1 lakh per year are subject to LTCG, so plan your exit accordingly. In case you plan to redeem your SIP after 5 years, try to spread your profits across years so that you get a bigger benefit of tax-free gains. This can boost your post-tax returns.
Step 8: Regularly clean your portfolio of laggards
Portfolio laggards are like rotten apples. A handful of them can spoil the show. How do you decide? Give a fund 6 quarters time. If it is consistently underperforming its peer group on a rolling basis, you are better off exiting the fund. At that point, don’t worry about exit loads, capital gains tax etc. It is important to get out of laggards.
Step 9: Review your plan on a periodic basis
It is one thing to create a mutual fund portfolio. They must continue to be in sync with your goals and the current opportunities in the market. That can be figured out through periodic review. Review does not mean changes to your portfolio. But a regular review helps you highlights such shortfalls in your MF holdings.
Step 10: Focus on asset allocation
Surprisingly, this never goes out of fashion and it is a summation of all the previous steps. When you have a fixed allocation approach, you are automatically high on cash when markets are low and fully invested well before the market peak. This not only monetizes your portfolio but also enhances returns on your MF portfolio over time.