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Pawan Agrawaljanuary 27, 2015

Recently I have come across several investors who have the opinion that equity investment for short duration i.e. 1-2 years yields better returns than the investments made for 5 or more years. Due to this opinion, investors want to invest in equity funds for 1-2 years and then plan to re-invest the money again for 1-2 years and so on to get the maximum returns.

After talking to them, I realised that they have formed this opinion after going through the performance tables of various equity funds in the newspapers and on various online portals.

To understand the point, let’s have a look at a typical equity fund performance table, as we see in any media.

Fund Performance Table

* Returns as on 26th Jan 2015

# The above schemes are for illustration purpose only and should not be considered as an investment advice

As you can see, the returns over last one year are much higher than annual returns of last three years, which in turn are higher than that of 5 years. After reading such a table, a layman may easily reach to the conclusion that is the very basis of this article.

The Real Picture

The last one year returns of any fund shall reflect its performance exactly over last 365 days. Since the markets may move up or down sharply over short duration, the performance of a fund may look quite attractive (or negative) depending upon what has happened in the last 365 days.

The returns over duration of more than a year are termed as CAGR or compounded annual growth rate, which reflect the performance of the fund on a compounded basis over a period.

From the above table, investment in Mirae Asset India Opportunities Fund in last one year would have grown from 1 Lac to 1.6 Lacs considering its one year return of 60.07%. Its 29.52% returns over 3 years means that the fund has given total returns of 117.2% (29.52% returns compounded every year for 3 years).It means in last three years, an investment in this fund would have grown from 1 lac to 2.17 Lacs. Similarly, total returns of this fund over 5 years are 133.8% (18.52% returns compounded every year for 5 years).

Returns over long periods of 5/10/15/20 years may not seem high on annual basis but as the time progresses, these returns compounded over long periods create high absolute returns. E.g. ICICI Top 100 Fund’s last 16 years annualised return of 21.42% may seem miniscule in comparison to its 2231% absolute returns over the same period, though both are true facts, presented mathematically in a different manner. An absoulte return of 2231% is nothing but 21.42% returns compounded over 16 year period.

Should you re-invest your money every year in a new fund?

I would like to answer this question after you have seen this table.

The above table illustrates the returns generated every calendar year by three schemes from 2011-14. As can be seen, in 2011, all three schemes generated negative returns. On the basis of these returns, none of the investors, who look at only 1-2 year investment, would have invested in these schemes.

In 2012, the same schemes generated huge returns. Thus, a person who was looking at only 1 year return in the beginning of 2012 would have missed these golden opportunities.

In 2013, these schemes generated returns that were only comparable to bank deposits. An investor, who would have got lured by looking at one year returns of these schemes(for the year 2012), would have felt disappointed and may have exited these schemes.

Making a comeback, these schemes again generated huge returns in the year 2014, quite contrary to their year 2013 performance.

The above example clearly demonstrates that last one year returns are not the true reflection of the potential of an equity fund. Any person who is looking at only last 1 year returns and investing (or not investing) in a specific scheme may actually face huge disappointment.

Conclusion

As can be understood from the above examples, the returns over short period reflect sharp movements of stock market whereas the long term returns present a true and clear picture of investments and the kind of returns we could expect from them. The time we give to our investments is more important than chasing the highest returns investment option. Instead of focussing on last one year’s returns, investors should work on a structured investment plan with appropriate asset allocation as per one’s financial goals, and should start as early as possible to reap extraordinary gains from the power of compounding.

Happy Investing!

Pawan Agrawal is the founder and managing partner of Investguru. You may reach him at [email protected] .