The e-paper Live Mint reported on 4 Sept 2019, that the average interest on Public Provident Fund (PPF) for the period Financial Year 2014 to 2019 was 8.21 %. In the same period Live Mint reported that

• Large Cap mutual funds earned 7.79 %

• Multi Cap mutual funds earned 8.57 %

• ELSS schemes earned 8.53 %

The implication of this information is

• Mutual fund investors who carry a considerable investment risk are not compensated for the risk they carry
• Mutual funds and PPF seem to be in the same league of investment returns, both delivering more or less the same returns

Why Invest in Mutual Funds?

The question that follows is why should one invest in high risk investments if the returns are more or less the same. I had pointed out earlier that in the calendar year 2018 (click here for the article) except for a few, all mutual funds earned a negative rate of return. Even the 5-year data is not encouraging one to invest in mutual funds.

Don’t Forget to Factor Volatility when assessing return

There is however another aspect to measuring and analysing mutual fund returns. Mutual fund investments are risky. The NAV does not keep going up, up and up. It goes up and it goes down. The frequency and the degree of the increase and decrease in NAV is called volatility. Volatility kills a large chunk of the expected return on mutual funds.

What happens to your investment when there is volatility

Let us look at a simple example. Suppose you had purchased a mutual fund at NAV Rs. 100 and after one month it falls to Rs. 90, a 10 % drop. For this mutual fund to again quote at an NAV of Rs. 100, it will have to rise at more than 10 %, just to ensure that you are in no-profit no-loss situation. Suppose the agent selling to you promised you 15 % on your investment of Rs. 100 (which is now quoting at Rs. 90), the NAV will have to increase by 27.7 % so that you get the promised 15 %. This is a tall order . It is most improbable that the NAV will rise by that magnitude.

NAV volatility produces a sequence of returns in a period of time and the sequence, when volatile, can erode you returns. Which is why we should not be concerned about returns on investment, but returns to the investor.

Returns on Investment vs. Returns to the Investor

Returns on the investment is shown through projected CAGR calculations. Returns to the investor is what part of that projected CAGR is actually realized after accounting for volatility. If you read my article And the Tortoise Wins, you will see that the returns on a risky investment, in the long run will be less than the returns on a low risk investment. More on this the next time.

Till then Sell Risks Not Returns