How investors get fooled into buying mutual funds with wrong expectations

Published: August 16, 2019 at 9:25 am

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Most investors, thanks to wonderful propaganda by the AMCs, believe mutual funds would give them fantastic returns and invest with wrong expectations. They also are made to think “staying investing” will get rid of risk, although it never will*. Here is an example of an ICICI mutual fund ad that helps drive in the wrong message. Of course, by “mutual fund” I am referring to “equity mutual funds” as is believed by many.

* See: Stock market investment risk will not reduce “over the long term”! As readers may be aware, I recently scoured through ICICI Mutual Fund factsheets to show distributors were enticed to push ICICI Prudential Asset Allocator Fund. The front page of the Jan 2016 factsheet front cover caught my eye. There are so many things wrong and misleading about it that it deserves a full article

How investors get fooled into buying mutual funds for wrong reasons

The ad urges: STAY INVESTED Your mutual fund investments need time, just like your relationships. To support this claim it says, Remaining invested in equities has given up to 5X* growth over 10 years.

There is always a * with such statements and in this case, it is: *Based on an average of 10-year daily rolling returns, Equities have grown by 5.4 times! There is an additional note: Data Source: S&P BSE Sensex from Jan 01, 1990 to Dec 31, 2015, plus the obligatory Past Performance may or may not be sustained in future

How investors get fooled into buying mutual funds

Aswathhama is dead*

* I don’t know if its a man or an Elephant.

Just about everything about this and such ads is wrong. First is the claim that mutual funds need time. Time for what? To grow? The unstated claim is, if you give your investment enough time, they will not fail you. Of course, this cannot be said explicitly as it would be against the second obligatory tune: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Second, to support this, the data is “up to” 5X growth over 10 years. A naive investor would miss the “up to” and focus on 5X growth over 10 years.

Third the claim of “up to” 5X growth is based on  “average of 10 year daily rolling return” and the 5X is actually 5.4 (wow 0.4 more!). How many investors would understand first understand what rolling returns stand for (assuming they even see the fine print)?!

Fourth how many investors would recognise that “average” implies there are some returns below average and some above. So one cannot use the average return and claim “up to 5X growth”. You can do that only if you use the maximum return.

Fifth how many investors would bother to check how the 10-year daily rolling returns of the S&P BSE Sensex from Jan 01, 1990 to Dec 31, 2015, would look like? They might throw up if they saw this.

There are 3754 10-year return data points in the green line based on Sensex price data. To account for dividends, I have added 2% to create the while line (Sensex TRI). The Nifty 50 TRI (actual data) from 1998 is also shown (pink line). Clearly, a 2% dividend is a bit of an overestimate but that is the least of the sins here.

Sensex Rolling as per ICICI MF factsheetSixth The returns range from 25% to 0% (yes, over 10 years) if dividends are (approximately) considered. For such a spread in returns, the idea of an average is useless. In the book, Investing with the Trend: A Rules-based Approach to Money Management, Gregory L. Morris gives this example:

a six-foot man drowned while trying to wade through a river that was only 3-foot on average

This is exactly the situation here. Investors would latch on to cherry-picked past data and build incorrect expectations. They are guaranteed to drown in them and I think it has already started.

Seventh “5X* growth over 10 years”, 5.4 to be exact corresponds to annualized return of 18.4%. Even for 2016, 18% future annualized return expectation is a bit too much. The average I get for the above data is 14.7% (including 2% dividends). Even if one claims that my numbers are wrong,  clearly the 18% number used by ICICI MF cannot be “based on the average” as claimed.

Now consider, how many can convert 5X growth into an annualized return, understand that it is not annual return, how many can understand how volatile the journey can be with zero guarantees of success.

For the record, this is the 10-year rolling return data up to Aug 2019 (from Jan 1990). That does not help the “average” in any way!

Sensex Rolling Returns 10 years

Do not blame the AMC or its advisors

Sure, ICIC MF has embellished the data to drive a message – give me your money – but that is how a business works. Investors do not bother to verify facts, read the fine print (let alone understand it), or take disclaimers seriously. They see what they want to, and assume they have seen enough.

I am not trying to say, avoid mutual funds! Only saying that do not invest for the wrong reasons, do not invest with the wrong expectations. There are zero guarantees that equity investing will work.  Yet, it is necessary. So the only way out is, learn to manage risk better.

How does one do that? Invest with a target corpus in mind instead of a target return. In fact: Do not expect returns from mutual fund SIPs! Do this instead! Invest with a suitable asset allocation (equity and fixed income investment ratio), plan for a change in this ratio from day one and reduce equity in a step-wise manner. This has been shown to effectively reduce risk in an investment portfolio. All these are automatically factored in with the Freefincal Robo Advisory Software Template

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About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
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