Beware : In Investing , averages can drown you.
The biggest misconception that Mutual Fund Investors do is looking at the Mutual fund fact-sheets and choosing funds solely based on their past performance, that is the equivalent to driving a car looking at the rear view mirror. Let us take as granted that the past is the only basis to judge the pedigree of the fund and the manner in which the fund manager has performed in the past is likely to give a clue about how he or she is going to be effective in managing their portfolios in the future, but that should be one of the criteria, not the only criterion.
The next is about the average returns that the fund fact-sheets display. When you look at a fund with a 10 year plus track record, you see that the since inception return of that fund is an impressive 15.50 % ( CAGR, Compounded Annualized Growth Rate),meaning that on an average every year that fund has delivered a 15.50 %, however you can get an average of 15.50 % in any of the two forms,
Option 1 : year 1 : 14.50%, year 2 : 16.50%, average is 15.50 %
Option 2: year 1 : - 22.00 %, year 2 : 53.00%, average is 15.50 %
Honesty admit that you hadn’t ever thought of the second possibility. Most of the time, you will have option 1 like scenarios, but once in a while you will encounter the option 2 returns… the implicit belief is that when you have a -22% return in a year, you need to wait for the 53 % return in the next few years so that the overall average is on par with the expectations of Equity investments. If you are fearful or anxious and move out at a loss, then the averaging doesn’t work for you.
As they say, averages can drown you. Can you drown in a pool of water with an Average depth of 12 inches, if your answer is no, you need to reframe your mind, you can drown in a pool of water that is on an average 12 inches if one end of the pool is 1 inch depth and another end which is over a kilometer away is 10 feet, if you do a simple average you could still get 12 inches, but if you are 5-6 feet in height and do not swim and are in the deeper end of the pool, you could drown.
So the next time you invest, let past performance be one of the many criterion you use to choose your fund. Also the averages can be deceptive, so ask for more data to study before you pick your fund of choice. Happy Investing!!!
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