When you invest your money with a mutual fund, you don’t normally think in terms of losing money.
All you want is to make money. And this must be your fund manager’s goal as well, or so you may think.
But if you read most mutual fund advertisements and what fund managers boast about on business channels and in newspaper interviews, their ultimate goal is to ‘beat the market’.
In fact, the entire mutual fund industry seems to have conspired against the small investor by pitching him nothing but this – “Give me your money, and I’ll help you beat the market!”
What is interesting is that most mutual fund investors also get stuck into this rut of beating the market, and this is the only factor they look at while selecting their fund.
The fund that has beaten the market in the past gets an upper hand over the one that has failed to do so.
“So what is the problem with this approach?” you may ask. “Isn’t sensible investing all about beating the market or earning more money than what some other fund can earn for me?”
Your thinking isn’t wrong, dear investor.
This ‘beating’ thing has been long ingrained in our brains as the only metric to show our power, intelligence, and value over the ‘beaten’.
So, while getting a salary hike of 20% would make me very happy, knowing that my colleague got a 25% raise would make me feel pathetic.
Or as a scene in the movie 3 Idiots suggests, “It feels bad when a friend fails, but it feels even worse when he comes first.”
This mindset is very much visible when it comes to investing in stock markets as well.
The fallacy of ‘beating the market’
By the way, have you ever noticed that this yardstick of ‘beating the market’ works only in a bull market?
During periods of bull markets, and especially during long bull markets, investors develop a myth that a fund manager’s goal is to match or beat some benchmark for a market that is rising.
Most fund managers also get into this loop. All they want to do is to beat the returns earned by the competitor fund and the benchmark index, which is mostly the BSE-Sensex in the Indian context.
In fact, this ‘beating the Sensex’ theme becomes the most popular basis upon which to judge performance.
But this is all bogus, as the fallacy of this belief is openly exposed in a big bear market.
During such periods, when stocks across the board are falling like nine-pins, even fund managers who succeed at their stated goal of beating the Sensex can ruin your retirement.
In the real world, you will be (surprise!) devastated if you lose 50% of your invested capital, even if the Sensex falls more than that amount, say 60%.
See this chart that shows the assumed movement of the BSE-Sensex and a mutual fund’s NAV during rising and falling markets.
The mutual fund has beaten the market when stocks are rising, and it has also beaten the market when stocks are falling. Or is it so?
“The markets are falling, but we are falling lesser,” is the fund manager’s claim when the chips are down.
But the investor is enraged – “I entrusted my money to you so that you can grow it over a period of time, and what have you done with it?”
But isn’t this an unnecessary reaction from the investor whose sensible, proper goal of investing was always to beat the Sensex?
In falling ‘only’ 50% as compared to the Sensex’s 60%, hasn’t the fund manager again beaten the Sensex? So why blame him now?
The real truth is…
Well, the harsh (but real) truth about investing is that ‘beating the market’ is not a sensible, proper goal.
The only goals of investing you must have are:
- To keep money (capital protection), and
- To make money (capital appreciation).
These follow from Warren Buffett’s two rules of investing:
- Rule No.1: Never lose money.
- Rule No.2: Never forget rule No.1.
These rules suggest that mutual fund managers who successfully protect your capital and make money for you in the long run and across changing environments are truly serving you.
But those whose only goal is to beat the Sensex are just the product of bull markets, and will leave you high and dry during bear markets.
Running faster or running smarter?
I believe that ‘beating the market’ is just a whim.
The reality is that your core goal must not be to beat the market, but to meet your financial goals with comfort.
To achieve that, whether you earn same as the market (Sensex), or 1-2% here or there as compared to Sensex’s returns, makes no sense.
It’s true that majority of all mutual fund managers have not been able to beat the market in the last 20 years, but then you are not a fund manager and your investing performance won’t be judged by whether you are able to beat the market.
Instead, it will be judged by whether you and your family are living comfortably after your retire from work.
Remember, trying to beat the market is like climbing onto a treadmill that never stops. It eventually exhausts you, and you come flying off it.
I remember a small story that will make this fallacy about ‘beating the market’ clearer for you.
Once, two guys were hiking through the jungle when they spotted a seemingly hungry tiger. One of the guys reached into his bag and pulled out a pair of sneakers.
His friend looked at him shockingly, and asked, “Do you really think those shoes are going to make you run faster than that tiger?”
The second replied, “I don’t have to run faster than that tiger. I just have to run faster than you!”
You got the idea, right?
In the same way, the idea in investing is that your stocks or mutual funds don’t need to earn you more than the markets (or your friend, relative, or the fund manager).
Your investments just need to earn you enough (while protecting your capital) to meet all your long term financial goals and live your life happily in your golden days.
Every other idea is a sham.
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Thanks a lot for taking this initiative to educate young investors like me.Ur posts are very informative
Vishal Khandelwal says
Dear Mr. Vijayshankar,
Thanks a lot for your kind feedback. You’ve motivated me to strive harder to provide greater value to my readers.
Is there any fund manager in india ‘who successfully protected your capital and make money for you in the long run and across changing environments are truly serving you’? – I don’t think so.
While theortically any investor would love to have a fund manager who can always protect the capital and get an inflation adjusted postive return, in reality, that never happens. If the market/index perfroms very well at best the fund manager is going to beat either that returns or else under perform it! He is not bothered about your capital or returns. Even if we read MF KIM Documents, it is all about beating the marked index and not about any capital appreciation and capital protection.
But as you rightly pointed out ‘those whose only goal is to beat the Sensex are just the product of bull markets, will leave you high and dry during bear markets (like the current ones)’.
Vishal Khandelwal says
Yes Ajay! I’ve had a great experience investing in funds managed by Prashant Jain of HDFC, whom I count amongst one of the best fund managers in India. In any case, as an investor, beating the market is not my primary aim when I am investing in stock or mutual funds. It is capital protection and appreciation over the long run, and the 5-6 funds I’ve invested in so far over the past 8-9 years have helped me do the same.
Can you guide me regarding the diversification in the MFs. Like If I have long term horizon, how to select between large cap or mid cap. How much schemes i should be invested in simultaneously.
I do have great respect for this fund manager and I have invested a significant portion of my money in funds managed by Mr. Prashant Jain and quite happy with the risk adjusted returns.
We may need to add a time element in your article that is capital protection and capital appreciation over a period of X years of investement. Then the funds managed by Mr. Prashant certainly fits over there. For that matter another fund house doing a great job on this front is Quantum.
Vishal Khandelwal says
Yes Ajay. And Quantum’s LTEF is another of the 5-6 funds I hold 🙂
Can you provide us a good portfolio where we can seek both Capital Appreciation and Capital Protection both
dr bhupat choudhary says
i am a novice in equity investment but had invested in few ELSS funds past few years..My query is
1. How come the so called experts (fund managers) can’t minimize the losses during falling markets? Is it must for a mutual fund manager to remain present in every stock in his portfolio despite falling market (bound by any law/ regulation)?
2. there is tons of inspiration/ motivation about investing in equity but for novices like me a single question always demotivates me which is – I see this investment as highly volatile ( I supposed so mainly because of its liquidity only). there are giants, mega weights who with all their technicals, modern equipments, legal – illegal deals & also their huge money/ media power turns the tables with sole aim to reap maximum gains, to the extent of snatching/pulling out maximum small investors money. So how one can feel assured of his investment that also for long term. I had bunt my money in Reliance Power IPO (& still feel the euphoria followed by depression…). I wonder how the regulatory bodies don’t take any action for such white collar frauds, over valuations….? Banks have their norms on financing a project & there are laws to recover the losses but there seems no such regulation/ law to recover public loss even in primary market then forget to expect any regulatory bodies for secondary market ?
3. Regarding overall fundamental values of companies…. they are left far behind & not realistic. Blue chips are always pricey, slow growing.. while small – mid caps are risky/ elusive… 1 in 1000000 make for long run. Overall the whole brighter picture we see is tip of iceberg.
In my view- its a jungle truly a Lions sanctuary, where herds of deers are lured to lush green fields only to feed the Lions. One should always remember Lions v/s Deers advantages & disadvantages..
Sorry for little long comment,
Thanks for patient reading,
Thanks in anticipation of reply,
Pradeep Gowda says
Yes you are right. its capital appreciation and capital appreciation that one should seek.
This what Howard Marks also said in his first memo in 1992, about whom I came to know from you only.
He said that in order to early extremely good returns people might do stupid things that may work one year but will cause losses in some other years, so in net, we lose money.
I think Graham also suggested for adequate returns.
Losing money is the worst thing that can happen,