Why Focusing Only on Past Performance Can Be a Mistake in Mutual Fund

3 Jan 2025 , 01:22 PM

It is human nature to be attracted by funds with a good record of past returns. After all, past success appears to be a better predictor of the future than anything else.

However, this is one of the big mutual fund mistakes, as individual investors pay a heavy price for solely relying on a ‘successful’ history of returns. This explains why historical data alone is misleading and what you must look for when choosing the best mutual fund.

Past Performance

The track record chart and tables are visually pleasing, showcasing impressive growth in specific periods. This creates a strong emotional bias, making investors feel that this high return will continue infinitely.

The key disclaimer, “Past performance is not indicative of future results,” is an essential reminder that this data does not necessarily indicate future happenings. Market conditions change, economic factors shift, and fund management policies alter, all of which can significantly impact performance.

Why Track Record Can Be Misleading

The key disclaimer, “Past performance is not indicative of future results,” should be acknowledged before investing to avoid the following Mutual fund mistakes:

• Every market has booms and busts. A fund that performed exceptionally well during a bull market might struggle during a bear. Comparing past performance based on the former creates misleading security.
• Sometimes, a change in the fund manager could significantly affect the performance. It is due to differences in the expert’s experience and investment strategies.
• Over time, a fund’s investment strategy may also change, even if the manager remains the same. This might happen due to market environment fluctuations or the fund’s objectives. Carefully assess such anomalies to prevent Mutual fund mistakes.
• Sometimes, the performance can be ascribed to a statistical anomaly or a lucky bet. However, this hardly tells us about consistent skills or a repeatable investment process.
• Mutual fund past performance does not necessarily reflect the risk taken to achieve those returns. For example, a fund could have made an extremely high return based on excessive risk that might be dangerous in case the market does not favour it.
• The period chosen for measuring past performance can significantly influence the outcome. A fund may appear great over 3 years but not as good over a decade.

What to Look at Beyond Past Performance

It is advisable not to depend solely on the performance. Instead, here are some crucial Mutual fund selection tips to consider:

• Study the fund manager’s experience, investment philosophy, and track record in various market cycles.
• Understand the fund’s investment objective, such as growth, value, or income, and its investment strategy. Ensure that all the data aligns with your investment goals and risk tolerance.
• Pay attention to the fund’s expense ratio. It is the annual fee charged to manage the fund. The lower it is, the more your investment returns stay in your pocket.
• Understand the standard deviation, beta, and Sharpe Ratio to get an idea of volatility in the fund.
• Finally, the last point of the Mutual fund selection tips section is to consider the composition of the portfolio’s holdings. Investors can study them to understand diversification and exposure to asset classes and sectors.

In Conclusion

Although Mutual fund past performance is helpful for some insights, it is not the sole factor you should consider when selecting your mutual fund. Consider numerous factors in your selection process to avoid Mutual fund mistakes and increase your chances of success. Seek a financial advisor to give you personalised advice and achieve your long-term financial goals.