The Gap Between Investor Returns & Investment Returns

Many investors claim that the returns they receive do not correspond to those represented by fund companies or even numerous mutual fund rating agencies. This disparity in returns irritates investors. As such, this article will help you understand why there is a gap and how to fix it 

Equity mutual funds have evolved as a formidable investing alternative during the last decade or so. A study of the 10-year returns of several fund categories demonstrates this concept.

As of July 19, 2022, the 10-year category median returns for open-ended mutual funds, including Large-Cap, large and Mid-Cap, mid-cap, Small-Cap, flexi-cap and multi-cap funds are 13.35 per cent, 14.61 per cent, 18.19 per cent, 17.73 per cent, 14.43 per cent, and 14.53 per cent, respectively. This makes it

clear that over the long run, equity mutual funds outperform Debt Funds and other fixed income investments by a significant margin. The assets have soared as a result of this parallel phenomenon. Open-ended equity fund assets were worth ₹1.8 lakh crore in June 2012, but they were worth ₹12.86 lakh crore in June 2022, representing a 21.73 percent annualised increase.

Furthermore, figures from the Association of Mutual Funds in India (AMFI) for the previous three years suggest encouraging growth. The monthly SIP flows increased from ₹7,917 crore in June 2021 to ₹12,276 crore in June 2022, representing an annualised rise of 15.74 per cent. However, a large number of investors think that their returns do not correspond to those claimed by the asset management companies or even other mutual fund rating agencies. This disparity in returns frustrates investors and leads them to conclude that mutual funds are not for them.

Carl Richards used the phrase ‘behaviour gap’ in his book ‘The Behaviour Gap: Simple Ways to Stop Doing Dumb Things with Money’. He used this concept to explain the gap between the return an investment generates naturally over a specific timeframe and the return an investor obtains on that investment. The outcome is typically not favourable to the investor. The behaviour gap is simply the difference between the rate of return on an investment over a certain time period and the rate of return that investors actually obtain on that investment

There is nearly always a difference between investment returns and investor returns. The assumption behind investment returns that you see in the media or in marketing materials is that you invest a lump sum at the beginning of the period and then leave it alone without making any more purchases or sales. You do not switch funds. You simply purchase once and keep it. Investor results reflect your actual return – the profit you get by buying and selling your investments or switching between investments as you look for the newest fad.

Reasons for the Gap
The gap might be caused by a variety of factors, or a combination of them such as timing the market, purchasing (or selling) based on previous performance, pursuing a fad, or simply electing to exit the market when it is briefly down.

Entering at Euphoria
Investors invested ₹75,672 crore into equity mutual funds between March and July, 2015. This was the point at

which foreign institutional investors became net sellers. They sold net ₹22,599 crore in shares from April to August, 2015. This type of behaviour has recently been observed.

According to the table above, during October 2021 to June 2022, equity mutual fund inflows totalled ₹1.55 lakh crore, whereas FII outflows totalled ₹3.84 lakh crore. This is almost double the amount invested in equity mutual funds. It should be noted that index funds, exchange traded funds (ETFs) and fund of funds (FoF) were not included in the above computation.

Switching Investments
Some studies across the world have indicated that retail investors are often not disciplined since they switch assets frequently. They are not long-term investors. This is made clearer by the statistics given by AMFI.


Tips to Optimise Investment Returns
✔ Investors should develop an investing plan based on their financial circumstances and risk tolerance.
✔ If you are unable to design an investing strategy, seek the help of an experienced financial advisor.
✔ When managing a portfolio, an investor should cultivate investment discipline and remain emotion-free.
✔ Regular portfolio assessment should be done in response to changes in financial situation or economic conditions.
✔ When the market is turbulent, investors should not worry since market corrections are common.
✔ An investor can seek professional counsel while also conducting his or her own study.
✔ To maximise market returns, an investor must remain invested and make sensible decisions that provide consistent returns. Investing in assets with better investment returns can help investors earn more money.

The graph above depicts the average holding period of equity funds by retail and high net worth (HNI) investors over the last decade. When we look closer, we can observe that there is a significant drop in the greater than 24 months’ category and a minor gain in the 6-12 months’ category. This demonstrates the shrinking investment horizon for retail equity investors. With that in mind, it’s hardly surprising that many investors in equities gripe about sub-optimal returns.

Emotional Decision-Making
Retail investors tend to respond more when they are experiencing a lot of life changes, such as a financial crisis or approaching retirement. Many studies have shown that people overestimate their abilities, whether they are investing or driving. They may overestimate the accuracy of their choices due to overconfidence.

Behaving Irrationally
In the stock market, herd behaviour is fairly obvious. People tend to follow the herd. When the media constantly reports about the economic downturn, most retail investors sell their investments without first analysing their portfolio and circumstances. Furthermore, they strive to imitate the star fund

manager by purchasing the stocks that they purchase and selling when they sell.

However, in this case, investors generate a return gap since they are uninformed of the fund manager’s investing plan. Furthermore, the information they get is delayed in nature, making it pointless to duplicate. Also, retail investors have a ‘loss aversion’ bias. Even if certain funds are in the negative, they will not sell in expectation of a rally, despite the fact that they have little chance of rising again. In such instances, it is wise to book losses and transfer to better-performing funds.

Timing the Market
Another explanation for the disparity between investor returns and fund returns is that investors prefer to stay out of the market during critical moments. Equity returns do not compound in the same way that debt returns do. Instead, they arrive in bits and pieces. After a lengthy period of slump or stagnation, the market may unexpectedly bounce. And if you stay out of the market when the markets bounce, your total returns will suffer. To investigate this phenomenon, we invested ₹10,000 in the Nifty 500 Total Returns Index (TRI) and compared it to investing in the Nifty 500 TRI after excluding the best 20 days.

As seen in the graph above, if you invested ₹10,000 on July 19, 2012, you would have accumulated ₹37,897 by July 19, 2022. If, on the other hand, you invested ₹10,000 and missed the market’s best 20 days, you would have accumulated ₹17,988.