Every tenth rupee invested in the Indian equity markets belongs to a mutual fund investor. Cumulatively, the collective wealth of all mutual fund investors exceeds $500 billion, or Rs 43,00,000 crore. That may sound like some serious wealth for Indians. However, that money is concentrated in only 8% of the people of India. Households in the country cannot be wealthy if they do not save and invest regularly to beat inflation.
The monthly bulletin of the National Stock Exchange, called the Market Pulse, compiles interesting studies on behavioural biases that influence mutual fund investors. It should help you understand the initial hesitance to use mutual funds as an investment vehicle.
There are three fundamental things to learn from the studies published over the past two or three decades. These include core biases and their impact, the impact of marketing and the role of knowledge. They were conducted primarily in developed markets like the US, but the findings are relevant to the Indian context.
Core Biases
There is a tendency to sell funds yielding higher returns quickly by realising profits. It is called the ‘disposition effect’. You tend to hang on to the underperforming mutual funds longer. That hurts your overall portfolio. Mutual funds have often complained about rapid churn in their portfolios, as the average holding period is less than 5 years. There is a significant wealth effect from compounding in equity investments after 10-15 years. The tendency to trade frequently and switch mutual fund schemes undermines compounding. It has happened in America and other markets before, and it is happening with you in India, too.
Marketing
Another study found that the flow of mutual funds is barely performance-based. It depends on how easy it is to find information to invest in. Aggressive marketing by mutual funds and industry associations, such as the Association of Mutual Funds in India, has created awareness of the processes. There are smartphone apps that enable investing without much effort. A lot of inflows are due to that convenience. Studies found that most people respond to recent performance and decide when mutual fund investing is mostly about long-term planning. It takes a lot of effort to find the relevant financial information. The study quoted in the NSE bulletin observes that people tend to rely on visibility and marketing as proxies for the quality of schemes. Funds that spend more on such visibility tend to attract more subscriptions for systematic investment plans (SIPs) or lump-sum investments. Even during new fund offerings (NFOs), high spenders garner more money.
Knowledge
Studies show that investment behavioural biases are heterogeneous and not universal. Among sophisticated investors, those with adequate knowledge tend to hold their investments for a long time. They usually buy funds that have low expense ratios. They are also not affected by the hype around recent developments in new fund offerings or performance. Those who are relatively unsophisticated or less knowledgeable tend to jump into schemes for quick returns or invest directly in equities or derivatives. If they invest in mutual funds, they end up choosing high-fee funds and prefer active funds to index funds. If you have limited knowledge, you will end up doing active management in your mutual fund schemes. The whole purpose of investing through mutual funds is defeated. Considering the relatively poor holding period in India, most of you probably do that.
What it means
Investment knowledge tells you that mutual funds are passive investments. Someone else is managing the money for you. You must accept the fact that fund managers are far more sophisticated than you are to manage that money. They have access to knowledge that you don't. You must learn to leave that to the experts and focus on boosting your income instead.