When it comes to picking the right mutual fund, the track record of performance is an important factor to look at. But what many investors don't realise is that their method for doing so may be biased, leading to distorted conclusions. Wondering how? Well, how often do you come across investors who pick funds based on their returns in the last one year, or three years, or even five years? The fallacy of these measures is that they only look at returns at a particular point in time, i.e., returns made between two dates/price points. In other words, they measure a fund's 'trailing returns'. It is useful to look at when you want to know the returns you made from an investment. Suppose you made an investment three years ago and now you want to know the annual gain made as of today, what you calculate is a trailing return. But they aren't as useful in forming an opinion about a fund. That's because by looking at trailing return, you are speculating the future performance of a fund based on a single event, thus giving more weightage to luck. And it is as likely to be wrong as right. A fund, which has otherwise been a poor performer, may deliver strong returns for a brief period of time, propelling it to the top of trailing return tables. But that doesn't mean it has turned investment worthy overnight. Even a broken clock is right twice a day! Consider building a cricket team. Would you select a player who scored a century in the last match but could not make more than 20 runs in previous 9 matches or the one who averaged 80 in the last 10 matches? In a nutshell, trailing return is just a trailer and the complete picture might totally disappoint yo
This article was originally published on June 24, 2021.
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