Mutual funds (MFs) have been around for several decades in India. However, only a small percentage of Indian retail investors has invested in mutual funds. The trust in bank FDs is higher despite the fact that interest rates have been going down.
One reason behind lackluster response to mutual fund is that investors return is different from fund return. In fact, our team at CashRich, an online investment app studied around 1200 MF account statements to understand why significant section of retail investors have not gained much from mutual funds. The gains actually realized in the consolidated account statements are often lower than the returns expected from mutual fund investments.
Why are mutual funds working for a limited set of retail investors? More importantly, why are they not working for the rest?
During the research by the Finance team at CashRich, we spoke with 400+ retail investors to analyze their investment process. The investors were from diverse backgrounds with 45% from Tier 1 cities, another 35% from Tier 2 and the rest from Tier 3 towns. The age range was from 22 to 70 years with 73% male and 27% female.
As the study progressed, we were able to identify certain common attributes and behavioral bias among a section of investors. We were able to discern 10 categories of mutual fund investors based on investment process, behavioral traits and knowledge level.
1. Quora experts
This group (typically in their 20s) believes that financial advice is freely available online. They have taken investment decisions based on answers on Quora (an online Q&A website) or YouTube videos. Some of them have also relied on SMS tips and WhatsApp forwards. Some people do well by seeking the right advice because they know that Investments is not their favorite subject. Many of them have entered the financial markets after 2015 and the sort-by-highest-return investment methodology has not provided impressive returns yet.
2. Disciplined moneymakers
This group of disciplined investors understands that managing money is important. They have generally started disciplined investing in their 30s or early 40s. They understand that the return on their investments needs to outpace inflation. However, this group remains busy because of their professional demands and has no time for financial research. They generally engage a qualified advisor or financial planner. From the sample in our study, 34% female investors belonged to this group.
3. Jilted investors
These investors had started investing in 2007-08 and consequently suffered losses due to the great financial crisis. Feeling jilted, they currently have minimal exposure to mutual funds.
4. Investment gurus
Experience is the best teacher. In our study, we found 11 experienced investors (less than 1%) who are constantly monitoring the global economy and market developments. They had formal finance training and work experience in the investment industry. They do not need any handholding or advisory and can manage their money directly. Interestingly, many retail investors mistakenly believe that they are part of this exclusive club but their consolidated account statements do not support their claim.
5. Perfect wrong timers
These trend chasers often ‘buy high and sell low’. They have expertise in turning paper losses into actual losses with their lack of patience. It is not possible to predict and perfectly time the market for wealth maximization. But this group has the ability to enter at the peak and exit at the bottom of the market. When markets go down, they quickly stop their SIPs and prevent the cost averaging process to play out. Stopping SIPs abruptly is one of the reasons for below average MF returns.
6. Passive winners
Even though the concept of passive investments is relatively new in India, a small minority of investors have started utilizing low cost index funds/ETFs for long-term wealth creation.
7. Penny-wise
A section of investors has chosen to be penny-wise and pound-foolish. Fees in some form gets incurred for managing money. Some people may wish to save the fund management charges by trying direct equity while others might save the advisory fees of a RIA or distribution charges of an IFA. However, if the investment fails to meet its goal and only costs are saved while losing capital, then that is definitely not ideal. During last year, a good advisor would have ideally prevented losses from investing in small caps at the wrong time or getting caught in the wrong debt fund.
8. Dividend seekers
This set comprises mainly of retirees (age 60+) who rely extensively on fixed deposits (FDs) or Post Office savings schemes for monthly income. As an alternative, they have started investing in mutual funds with a dividend option to get regular cash flows. The dividend plan is an inefficient way to generate the monthly income. The word ‘dividend’ sounds alluring but ‘growth’ option can deliver more post-tax returns.
9. Asset mis-allocators
Someone with a savings of Rs. 1 lac/month invests just Rs. 3000/ month in an equity SIP. Rest Rs. 97,000 goes in a taxable FD/ RD at 7% (4.9% considering 30% tax). Trying to optimize the SIP returns by looking at ratings and returns will not have any significant impact on their
wealth. Investors who have high incomes but try to manage their money without professional help generally take this risk averse strategy (without considering the risk of opportunity loss).
10. Spray painters
This category of Do-It-Yourself investors have bought 10-15 random schemes at various points in time based on news articles or friends recommendations. Most people in this category were in their 20s or early 30s and with easy access to online mode of investment, created suboptimal portfolios in the absence of proper guidance.
In one case, we found only small cap SIPs from 5 different fund houses in an investor’s portfolio, started at the peak valuation levels of last year. The goal of the investor was to fund his child’s education in 2 years. His logic of selecting 5 different fund houses was to reduce risk through diversification, without considering the riskiness of the small cap category for a short period of 2 years. Several such naive diversification strategies are used regularly and highlights the great advice gap in India.
India needs thousands of good quality financial advisors spread over the country to deliver the real benefits of mutual fund investing. Ultimately, only a vigorous investment process based on optimal asset allocation, portfolio diversification and regular monitoring can deliver better long-term investment returns.
Sougata Basu is the Founder of CashRich and an Executive Committee Member of the India FinTech Forum. The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.
