Rolling Returns, Expenses, and Risk: How to Pick the Right Mutual Fund

Investing can feel unnecessarily complex, especially when markets are unpredictable. It's easy to get distracted by short-term news, market forecasts, and lists of last year's top-performing funds.

This guide is designed to help you ignore that noise.

We will focus on a straightforward, data-driven process for evaluating mutual funds. By concentrating on a few key metrics and a logical portfolio structure, you can make informed decisions and build a more resilient investment plan.

Three Essential Metrics for Fund Analysis

To accurately assess a mutual fund, you need to look beyond its most recent performance. These three data points provide a much deeper and more reliable view of a fund's quality.

1. Performance Consistency (Rolling Returns)

A point-to-point return (e.g., the return from Jan 1 to Dec 31) is just a snapshot and can be misleading. A fund's performance can look impressive or poor simply due to a favourable or unfavourable start and end date. Rolling returns offer a more comprehensive picture.

• What it is: A calculation of a fund's average performance over numerous overlapping time periods. For example, a 3-year rolling return shows the average return for every 3 years over the last decade or more.
• Why it's important: It reveals how a fund has performed through various market cycles, bull, bear, and sideways. A fund with strong and steady rolling returns is more dependable than a fund with irregular performance, even if it had one spectacular year. Look for consistency over time, not just a single high score.

2. The Cost of Ownership (Expense Ratio)

The expense ratio is the annual fee charged by a fund to cover its operational costs. This fee is deducted directly from your investment, which directly reduces your final returns.

• What it is: The percentage of your investment that is paid to the fund company every year.
• Why it's important: While the percentage may seem small, its effect compounds over time, resulting in a significant reduction in your potential wealth. Choosing a fund with a lower expense ratio is one of the most effective ways to improve your long-term results. For the same fund, a "Direct Plan" will always have a lower expense ratio than a "Regular Plan."

3. Volatility Level (Standard Deviation)

Returns tell you how much your investment has grown, but they don't tell you about the risk involved. Standard deviation is the primary metric used to measure a fund's volatility.

• What it is: A statistical measure of how much a fund's returns fluctuate around its historical average. A higher number indicates greater volatility.
• Why it's important: It helps you understand the potential for large price swings in your investment. A fund with high standard deviation may experience sharp increases and decreases in value. A fund with a lower standard deviation will generally have a more stable growth path. Choose funds with a volatility level that aligns with your personal risk tolerance.

A Logical Framework for Your Portfolio

Instead of picking funds randomly, structure your portfolio with a clear purpose for each investment. The "Core and Satellite" approach is a widely used and effective method.

• Core Holdings (70% of Your Portfolio): This is the foundation of your investment plan, designed for stability and long-term compounding. These holdings should consist of well-diversified, low-cost funds like Index Funds or Large-Cap Funds.
• Growth Holdings (20% of Your Portfolio): This portion is allocated to funds with the potential for higher returns, which also carry more risk. This can include well-managed Flexi-cap or Mid-Cap Funds that invest in a broader range of companies.
• Tactical Holdings (10% of Your Portfolio): This is a smaller, optional allocation for experienced investors with a high-risk tolerance. It can be used for high-potential categories like Small-Cap or Thematic Funds. Any losses in this portion should not significantly impact your overall financial plan.

The Financial Impact of a 1% Fee

To understand how critical costs are, consider this example. Assume you invest ₹50,000 per month for 10 years, and the investments generate a 12% annual return before fees.

As the table shows, the seemingly small difference in annual fees can lead to a difference of several lakhs of rupees in your final corpus.

Your 10-Minute Action Plan

You can apply these concepts immediately to improve your portfolio.

1. Select your largest mutual fund holding on your investment platform.
2. Find its 3-year and 5-year rolling returns. Evaluate its performance consistency, not just its one-year return.
3. Check its expense ratio. If you are invested in a "Regular Plan," you are paying a higher fee for commissions. A lower-cost "Direct Plan" of the same fund is nearly always available.
4. Look up its standard deviation. Compare it to the category average to understand if you are taking on excess volatility for the returns being generated.

Successful investing is not about predicting the future. It's about building a robust process based on factors you can control: your strategy, your costs, and your understanding of risk. By focusing on these fundamentals, you can make better decisions and progress toward your financial goals with greater clarity.

Disclaimer: The content is meant for education and general information purposes only.  Past performance is not indicative of future returns.. The figures mentioned in this article are indicative and for general informational purposes only. Readers are encouraged to verify the exact numbers and financial data from official sources. Mutual Funds are non-exchange traded products, and INDstocks is merely acting as a mutual fund distributor. All disputes with respect to distribution activity, would not have access to the exchange investor redressal forum or arbitration mechanism. Mutual Fund investments are subject to market risks, read all scheme related documents carefully before investing. INDstocks Private Limited (formerly known as INDmoney Private Limited) 616, Level 6, Suncity Success Tower, Sector 65, Gurugram, 122005, SEBI Stock Broking Registration No: INZ000305337, Trading and Clearing Member of NSE (90267, M70042) and BSE, BSE StarMF (6779), AMFI Registration No: ARN-254564, SEBI Depository Participant Reg. No. IN-DP-690-2022, Depository Participant ID: CDSL 12095500, Research Analyst Registration No. INH000018948 BSE RA Enlistment No. 6428.