Categories: Mutual Funds

Will I get more returns if I take more risk? Higher risk = higher returns?

Many investors are under the impression that to get higher returns, one must take on more risk. This is reasonably true if the investment duration is “long enough” and completely wrong for shorter durations. In a two-part post, I consider the risk and return associated with all mutual fund categories. This is an updated version of what I had previously discussed: The key to successful mutual fund investing

In this post, let me take the easy way out and consider a duration of 3 years. The easy way out because the data is readily available at Value Research. Many investors, especially first time ELSS fund investors believe 3 years is “long enough” to get “good returns” from equity. Well, let us find out. In the second part, I shall consider 5Y and 10Y – for this, I need to crunch the numbers myself.

First some basics:

Investment risk

Risk is defined by the standard deviation. That is, the monthly returns of a fund over the last 3Y is calculated. Then we find out the average monthly return and how much each return deviates from the average.

This measure of “deviation from average” is known as standard deviation. It is a standard, but a simplistic measure of risk (and therefore convenient).

Investment Return

This is simply the last 3Y annualized return or the CAGR

Mutual Fund Categories

These are the present Value Research fund categories. They are set to change due to the SEBI classification, but no harm is looking at what is available now.

Category Full Form
EQ-INTL International Equity funds
EQ-LC Equity large-cap funds
EQ-OTH Equity “others”
EQ-MLC Equity Multicap
EQ-MC Equity Midcap
EQ-IT Equity Infotech
EQ-CG Equity Consumer goods
EQ-SC Equity Small cap
EQ-PH Equity Pharma
EQ-INFRA Equity Infrastructure
EQ-BANK Equity Banking
DT-LIQ Liquid funds
DT-FMP Fixed maturity plans
DT-UST Ultra short-term
GL-ST Gilt short term
DT-ST Short-term debt funds
DT-CO Credit opportunity debt funds
DT-INC Debt income funds
DT-DB Dynamic bond funds
GL-MLT Medium and long-term gilt
HY-AR Hybrid arbitrage
HY-DC hybrid debt oriented conservative
HY-OTH Hybrid others
HY-DA Hybrid debt oriented aggressive
HY-EQ Hybrid equity oriented
HY-AA Hybrid asset allocation

Mutual Fund Risk ladder

So how do fluctuations in monthly returns increase across categories?

Right from liquid funds (lowest risk) on the extreme left, notice how risk increases in step-wise manner as you head to equity small caps on right (see the sudden spike in risk there). Please spend some time in locating each fund category in this ladder.

Mutual Fund Risk vs Return (3 years)

To plot this, let us first rotate the above graph.

The 3Y return (Y-axis) is plotted vs the 3Y risk. The horizontal axis for both the graphs are the same to enable comparison.

As you go from liquid funds to small-cap funds, notice how the spread in returns increases. There are some extreme points in the bottom right of the graph – these are international funds (eg. world gold mining fund)

Readers may be aware of an “infographic” published earlier: Assorted infographics on personal finance

Can you see the similarity?

As the investment risk (or standard deviation) increases, the range of returns possible increases.

What does this mean?

When risk increases, risk increases!! The return may or may not increase.  This is over 3Y. I am curious to see how this changes over 10Y.

Risk per unit return vs risk for all categories

Now we divide the risk by the return and plot it against risk.

Please take a while to spot your favourite mutual fund category in the plot. Notice that as risk increases, the risk per unit return also increases and at the highest levels of risk, the linear trend weakens.

Some data points deviate below the linear trend. Meaning higher returns and higher risk (lower risk/return)

Some data points deviate from the linear trend. Meaning lower returns and higher risk (higher risk/return)

So, Will I get more returns if I take more risk? Over 3 years, the answer is, maybe yes. Maybe no, but I will definitely get higher risk, if I take higher risk. duh!



Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. You need to only cover my travel fare for the session.

Connect with us on social media

Do check out my books

You Can Be Rich Too with Goal-Based Investing

My first book is now available at a 35% discount for Rs. 258. It comes with nine online calculators. Get it now.  The Kindle edition is only Rs. 199.

Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want

My second book is now only Rs 199 (Kindle Rs. 99) Get it or gift it to a young earner

The ultimate guide to travel by Pranav Surya

This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

Create a "from start to finish" financial plan with this free robo advisory software template

Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

About Freefincal

Freefincal has open-source, comprehensive Excel spreadsheets, tools, analysis and unbiased, conflict of interest-free commentary on different aspects of personal finance and investing. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. We do not accept sponsored posts, links or guest posts request from content writers and agencies.

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.

This post was last modified on March 6, 2018, 11:33 am


Published by

Recent Posts

Want to be financially free? Do not count on frugality! Worry about sequence of returns risk!

If you are someone who desires early retirement or you just want to save up enough to ensure income for…

22 hours ago

What is a living will, why is it important, how to make one & how it can help our loved ones

Let us discuss what is a living will, why it is important, how to make one and how it can…

3 days ago

Lessons from my SIP in Sundaram Select Midcap Fund

I have Rs. 500 SIP running in Sundaram Select Midcap fund since Aug 2009. As readers may recall*, this is…

5 days ago

Our elders were right! Why it makes sense to have children as soon as possible!

Our elders were right all along! In hindsight, it makes perfect sense to have children as soon as possible. A…

7 days ago

Fee-only Advisor Journey: Shilpa Wagh’s “money personality” lessons

SEBI registered investment advisor Shilpa Wagh shares her journey: from IT professional to a fee-only financial planner. Shilpa resides in…

1 week ago

How to select an equity mutual fund in 30 minutes!

Here is a video description of how to select an equity mutual fund in under 30 minutes using the freefincal…

2 weeks ago