Should one build mutual fund investment portfolio based on return only?

Is there anything wrong with the idea of investing in those mutual funds which have given highest return in say last 3/5 years? I do not understand why people worry about selecting diversified equity fund or debt fund; about large cap or mid cap fund. After all what matters is the return, so one should select those funds which have proven track records of better returns than others and select those with maximum returns. Is this idea wrong?

Should one build mutual fund investment portfolio based on return only?
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11 Replies to “Should one build mutual fund investment portfolio based on return only?”

  1. Because Past Performance is No Guarantee of Future Results.
    In fact every perspective mentions this statement because it’s almost a given that just because a fund, stock or any other investment had a good day yesterday does not mean that today will be just as good.

    Yes return does matter but what matters more is what caused the return. What in the economy, or the sector or group of companies caused the high returns. This is where research into the particular mutual fund comes in.

    This is the difference between technical and fundamental analysis. Part performance is just a small portion of technical analysis and understanding the details of a sector, economy, or mutual fund is fundamental analysis. Focusing your desicion based on only one of them will gurantee only luck. That can be either good or bad.

  2. No, because the past returns may not reflect future returns. The first thing to look at is the expenses a fund charges. And set up a portfolio that meets your risk tolerance.

  3. This is a math problem, and the answer can be derived from math. It’s not an answer that you should attempt to answer with hunches, or “common sense”.

    A common phrase heard is, “Past Performance is No Guarantee of Future Results”. But it’s actually much more than that. This has been studied, and actually recent past performance for stock funds (i.e. 3-5 years) is not statistically predictive of future returns at all. In other words, it gives you zero information as to what will happen in the next 3-5 years, statistically. Unusually high returns over a short period, is actually slightly predictive of below average returns in the short term future.

    This is counter-intuitive, which is why so many people make investing mistakes. They assume picking stock funds is like picking fantasy football players. If a player has dominated over the last 3 years, it’s statistically much more likely he will dominate the following year than a below average player will. This can be statistically proven. The same simply is not true for stocks, and this has been proven beyond all reasonable doubt.

    That’s why you diversify. The bitter truth is, NO ONE knows what funds will do well over the near term future. There’s a lot of salesmen out there (including CBNC) who want to appear to know, so that you keep tuning in to hear them, and they can be profitable. As has been said, there’s only three types of people when it comes predicting how particular stock funds, or stocks, will perform, 1) those who know they have no idea, 2) those who think they know but in reality have no idea, and 3) those who realize they have no idea but need to present themselves as knowing in order to sell you something (i.e. con artists, such as financial salesman and CNBC).

    There are some things that are predictive. One is that, in general, the higher the management fee the worse the fund will perform over time. They generally underperform by the amount of the excess fee. This is consistent with the assumption (which has considerable statistical backing) that no one knows what stocks or funds will do well. A fund with a 1.5% fee performs, on average, 1% worse per year than a fund with a .5% fee. What they’re selling you is that they’ll do more work to pick better stocks. There is zero statistical evidence that this can be done, and ample evidence it cannot be. You may as well pay someone to predict next year’s weather for a particular week that you’re planning a vacation. It cannot be done. And the sooner you stop paying people, or attempting yourself, to predict what cannot be predicted the healthier (financially) you will be.

  4. Yeah like everyone has been saying, “past performance is no indication of future results”.

    Realize that mutual funds invest in different securities. These securities typically include stocks or bonds.

    With stocks you are the owner of a company. With bonds, you are loaning money to either a company or government.

    Bonds are typically considered safer than stocks because they pay a fixed interest rate written on a bond and “mature” after a certain number of years at which point the full principle value is paid back.

    On the other hand stocks may or may not pay dividends, and stock prices fluctuate wildly depending on the market’s perception of the future growth and value of the company. Some companies are dependable and easier to predict (like utilities or consumer staples). Their stock prices tend to fluctuate less as the companies grow. On the other hand some companies have more uncertain futures and thus wilder stock prices.

    Often times the very same mutual funds which do great over a certain number of years turn out to do terribly over the next couple of years.

    For example bond funds have beat out stock funds by wide margins over the past 10 years because the economy has been so bad that people have been rushing to the safety and stability of bonds and bond mutual funds.

    However if the economy turns around stock funds will probably blow away bond funds. Especially if interest rates start to rise again (which would push bond prices down).

    I strongly recommend talking with a financial advisor if you have any questions about mutual funds or how they can help you reach your financial goals.

  5. No your view is absolute right but sometimes diversified equity mutual fund reduces risk in your investment.Sometimes thematic funds give extraordinary returns than those of diversified funds but at the sametimes it posses the risk that any bad news about the sector from macroeconomic point of view and your fund will be loser.If you track the funds then you will in 2006 metal funds gave highest returns, in 2007 power funds,in 2008 diversified,in 2009 pharma funds etc.So sector changes everytime.So first judge the mkt, i.e if the mkt is going for a downturn then avoid metal and power, and invest in FMCG and Pharma but if the mkt is going for a upside then invest in metal,power and diversified.

    for further query you can mail me at
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  6. What you say is not wrong but you are seeing only a partial side of mutual fund investment.

    The main difference between diversified equity fund, debt fund, large cap funds, mid cap funds is hidden in one word called “risk”. All investors would ideally like their investments to be risk free and giving high returns. In order to create a balance between risk and returns people opt for various types of funds for investment.

    A Diversified equity fund invests mainly in shares which has a high risk in short term horizon but given high returns as well (e.g.12% annual returns for 5 years horizon)

    Debt funds has a very low risk profile but they give comparatively lower returns (e.g.6-7% annual returns). If investor do not want to wait for 5 years as in case of equity investment, they they go for debt linked investment plans.

    Large cap funds are also equity linked funds which invests in companies having high market capitalization. Such companies are generally those companies that have huge turnover, profits and are continuing to do so for decades. In short that have a proven track record. When you are investing in a large cap fund your risk is minimized.

    But for mid cap and small cap funds the risk levels are higher as compared to large cap funds

    So to conclude, it is not sufficient to just look at returns of past while investing. It is also important to analyze the possible “risk” associated with mutual fund investments

  7. First you need to assess your risk appetite and your investment horizon. Small and mid-cap funds , sectoral funds are more volatile than large cap funds.Similarly while investing in a debt fund one of the most important factor is your investment horizon. According to your investment horizon you should select the debt fund.
    The question of fund performance arise after you have selected the category of equity or debt fund.

  8. Your Core investment should be in large cap funds. You can invest some money in multicap & midcap funds. Avoid sector funds as far as possible. If you invest in them – invest not more than 5-10% of your total investment. Sector funds give maximum returns or maximum losses. If a sector fund has done well in the last 3 years – and you are investing now – then next 3 years might not be good.

    Visit to learn more about mutual funds.

  9. I think it is always better to consult some expert when it comes to investing in the market because at the end of the day it is your hard earned money and only you can realize its worth.If you are planning to invest in the market then consult some expert like mansukh, religare, india bulls or even share khan because they can help you out in preparing a strategy that will ensure batter returns on investment

  10. Good question. The short answer is no.

    Ron has the best answer here, but there are a variety of reasons that you do not want to base your investment decisions based solely on return (see link below). The biggest one is that different asset classes do well at different times. The best asset classes over the last 3-5 years will in all likelihood NOT be the best ones in the next 3-5 years. NOBODY knows which funds (or asset classes) will perform best in the future – anyone who tells you otherwise is selling something.

    Instead, you should focus on low-cost funds that meet your objectives, and focus on funds WITHIN those categories that perform well on a risk-adjusted basis, compared to other funds in the same class (no need to pick only the “best” – just be sure the fund(s) you choose are in the top 25-50% in their category). If you’re just starting out, start with one or two good core funds, like index and/or target-date funds. I suggest using a fund family that has low fees, a good selection of highly-rated funds, and excellent customer service. My favorites are Vanguard, T. Rowe Price, and Fidelity.

    If you are constantly “chasing returns,” you will end up being a mutual fund trader (not investor), and you are virtually guaranteed to under-perform the market as a whole.

    Finally, I would highly recommend going to your library or book store and picking up one or two books on mutual fund basics – “Mutual Funds for Dummies” is a good one, as is “Bogle on Mutual Funds.” It really isn’t all that complicated, but this is VERY important stuff to know.

    I hope that helps. Good luck!

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