Funds with high returns can lose you money. Here's why

Choosing mutual funds solely based on their returns without considering other factors is similar to buying a car based on its top speed. While speed is important, it overlooks crucial aspects such as fuel efficiency, safety features and the intended use of the vehicle. Imagine buying an F1 car to go vegetable shopping through the busy streets of Mumbai. The same is the case with mutual funds. Investing in funds based on their returns alone - and not looking at their riskiness, your time horizon and goals - can lead to potential disasters. Here's why: Small-cap funds Even the worst-performing small-cap fund has delivered nearly 20 per cent annual returns in the last decade. And that's the worst fund. Admittedly, even we'd chop off such a fund's hand, but unfortunately, the devil is in the details. Go beyond the funds' returns, and you'll notice that the numbers hide years of frustration. That's right, small-cap funds have a tendency to experience long periods of zero returns. In fact, of the 10 small-cap funds with a 10-year history, six delivered zero returns for three years or more! Repeat, even the best of small-cap funds can run dry for 36 months and more. Moral of the story : If you have to pick a small-cap fund, ensure you have a longer time horizon, spanning at least seven years and are prepared to experience volatility. Small-cap funds can take long breathers Six of the 10 longest-serving small-cap funds delivered zero returns for three years or more in the last decade Name of the scheme 10-year returns (%) Longest period of zero returns Aditya Birla Sun Life Small Cap 19.26 3 years 4 months DSP Small Cap 25.23 3 years Franklin India Smaller Companies 23.7 3 years 1 month HDFC Small Cap 22.5 3 years Nippon India Small Cap 28.74 3 years Sundaram Small Cap 22.46 3 years 4 months Note: Returns of direct plans as of December 31, 2023 Short- to medium-duration debt funds These mutual funds are positioned as an attractive alternative to fixed deposits (FDs), promising higher returns at a slightly higher elevated risk. Even we recommend the shorter-duration funds as a better choice. So, when investors go shopping, they often choose funds that deliver the highest returns. Look at the table below, and you'll see some of these funds - which typically generate single-digit returns - offering as much as 27 per cent retur