why investing in the best doesnt always build wealth

Why Investing in the Best Doesn’t Always Build Wealth

No one wants to live a mediocre life. None of us is willing to surrender on the things that we believe are really the best to get hold of. To acquire the best of the best, we often go an extra mile and stretch our limits beyond our rational thought process.

 

For instance, Moms and Dads wish to be the best parents to their children. They desire to provide them with the best luxuries that they themselves couldn’t afford. They tend to improve their social status by holding the latest Apple products. Why? Because the brand Apple is the best. And it doesn’t matter if it takes a toll on their finances while pacifying their fascination towards acquiring the best. Be it clothes, shoes, perfumes or any other materialistic object; people love to own the best.

 

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When it comes to investing, we always look for what’s best to invest. Psychologically, it impacts our way of thinking by making us believe that when we own the best, the outcome will be highly rewarding. Our obsession with the word ‘Best’ makes us delusional while impacting our second-level of thinking. Repeatedly, we don’t even pay any attention to the points that are really important.

 

Mutual Fund industry has been progressing really well since the day of its inception. As per the book, How Fund Managers Are Making You Rich authored by Pravin Palande, the mutual funds’ assets have increased from Rs.47K Crore in 1993 to Rs.20L Crore in Aug. 2017. A growth of 18% annually over the last 24 years, of which 35% belongs to small investors. These figures simply imply that a healthy part of a household’s salary goes as investments into mutual funds.

 

A majority of the retail investors, like you and me, select these funds based on the performances they have delivered in the past 1-year or 3-years

 

Is it really rewarding to invest repeatedly in the best performers?

 

I have prepared a case study with real-time data records that have been downloaded from Value Research Online website. The dataset proves that investing repeatedly in the best actually dilutes the results. The results demonstrate that investing approach which is merely based on the best performers in the past 1-year is a sure-shot formula to build a half-baked portfolio.

 

The points of consideration that were involved in preparing this detailed case study are:

 

  • The dataset includes the data of Mutual Funds’ performances for the past 12 years, starting from Calendar Year 2007 (CY2007) till 17th July 2018 (CY2018)
  • Out of this list, the Top-5 best performing funds of the previous Calendar Year have been selected for the investments to be done in the current Calendar Year i.e. the funds selected for investments in the year 2007 are the best performers of 2006
  • This same approach has been used for the investments in the subsequent years. Say, the funds that have been selected to invest in CY2008 are the 5-best performers of CY2007, the funds that have been selected to invest in CY2009 are the 5-best performers of CY2008 and so on…
  • At the beginning of CY2007, an investment of Rs.5,000 is equally distributed (Rs.1,000 each) and invested in the best performers of CY2006
  • After a year, the corpus accumulated from the returns of CY2007 is equally distributed and invested in CY2008. This same strategy is followed for the next subsequent years till CY2018

 

And this is how the portfolio would have performed as per the above-mentioned strategy

 

 

 

 

 

As per the calculations, Rs.5,000 invested in 2007 would have become Rs.7,321 in 2018 (as on 17th July). That’s a CAGR of just 3.31%. Instead, if you had stayed invested in the best performers of 2006, your investment would have been worth Rs.12,664 with a CAGR of 8.27%. Moreover, investing in the index would have given you a better return of 8.58% resulting in Rs.13,100.

 

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You’ll observe that 90% of the funds haven’t been able to repeat their success stories by getting listed in the Top-5 Best Performing funds in the subsequent years. It’s not necessary that the best performers of the year will retain their position in the future too. And an investment strategy based on hopping in and out of the best performers actually dilutes your returns. 

 

Remember, your aim is to accumulate the corpus required to fulfill your future goals; not to beat the index. Stick with a couple of diversified set of funds for a long period of time and enjoy the magic of compounding. As Morgan Housel says – “The math of compounding means the biggest wins don’t necessarily go to those with the highest returns; they go to those who earn pretty good returns maintained for the longest period of time”

 

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The cover image has been taken from RT

 

 

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