Understanding the return-chasing trap
Investors often worry that poor returns will erode wealth, but experts say the bigger danger lies in how they react when another fund outperforms their own holdings. The phenomenon is commonly referred to as the return-chasing trap.
Radhika Gupta, chief executive of Edelweiss Mutual Fund, has highlighted that chasing recent winners can lead to higher costs, misplaced risk, and a churn of capital that undermines long-term goals.
Why performance chasing hurts portfolios
- Timing and churn: Switching portfolios in response to short-term outperformance can lock in losses and miss compounding periods.
- Higher costs: Frequent fund switching incurs transaction charges, exit loads, and higher ongoing fees, eroding returns over time.
- Misaligned risk: Popular funds may take on different risk profiles; chasing winners can tilt your overall risk away from your plan.
- Myth of the ‘hot’ fund: Short-run outperformance is not a reliable predictor of future results.
- Long-term perspective: A disciplined approach focuses on risk-adjusted returns, diversification, and sticking to a well-constructed plan.
Prudent investors consider factors beyond the latest performance, such as consistency, the fund’s investment philosophy, and the ability to remain invested through market cycles. The key is to maintain a patient strategy rather than react to every new winner.
