Year's hottest fund vs KISS fund: Which strategy delivers higher returns?

July 26, 1755. Giacomo was imprisoned.

Not for being a lawyer, a military man or a former clergy member. Not for being an author, a musician or a seasoned traveller.

Among other vices, he was imprisoned for being a ladies' man and his innumerable affairs.

Later, in his biography, Histoire de ma vie , which translates to Story of My Life, he wrote: "Cultivating whatever gave pleasure to my senses was always the chief business of my life."

You may know him better if I introduced Giacomo with his last name, Casanova.

Like Casanova, chasing the hottest fund of the year can seem exciting, but the results can be underwhelming.

So, curb the urge to chase flavour-of-the-season funds because you pay a lot of tax. And get lower returns. Not to mention sadness.

Stick or twist? The better investment strategy

Don't take our word for it. Let the numbers do the talking.

Consider Scenario 1 . You start with Rs 10 lakh in 2005. You switch funds every year. Not just any fund but the top-performing fund of the previous year. This way, you hope to ride the wave of momentum.

Scenario 2. The keep-it-simple-silly (KISS) strategy invested Rs 10 lakh in a solid fund in 2005 and held it for 20 years.

Here's how your money would have grown:

We examined all types of diversified equity funds: flexi-cap, large and mid-cap, and value-oriented funds.

Sticking to one fund would have made you happier in the long run. You would typically earn more money and avoid the hassle of switching funds, conducting research, completing paperwork, and so on.

Why chasing hotshot funds doesn't work?

Top-performing funds shine bright but fade quickly . Here's an eye-opener: no fund has retained the number 1 spot for two consecutive years among all equity funds in the last 20 years.

Category-wise, only two flexi-cap funds topped the charts for two straight years.

Large and mid-cap funds? Same story. Just two instances in 20 years.

Value-oriented funds? Only one fund retained their top-dog status two years in a row.

Now, if you're thinking, "It might not be number 1 next year, but it will probably stay in the top 3 or 5 or at least top 10", brace yourself. The results might surprise you!

Going from being the top performer to being a poor performer in just 12 months is real .

• Eight of the last 20 toppers sank to the bottom half of the table in the next year.
  
• Even when funds stayed above average, their ranks dropped dramatically: from 1st to an average of 40th the following year.
  
• If you look at the trends across categories, here's what we found:
  
• Flexi-cap funds: Six of 20 toppers delivered below-average performance the next year.
  
• Value-oriented funds: Seven of 20 toppers had similar declines.
  
• Large & mid-cap funds: Eight toppers fell significantly.

It turns out yesterday's winner isn't always tomorrow's hero.

Don't get tempted by the domination of sectoral and thematic funds . 11 of the last 20 toppers were either sectoral or thematic funds. That's because when they do well, they are terrific. But predicting when they'll do well is like a lottery. And if you are jumping on a sectoral and thematic fund based on last year's result, good luck. That's because investors often buy into sectoral funds at their peak, only to watch them plummet.

Then, there's the tax bite . Each time you switch funds, you're triggering a tax event. Sell your fund within a year? Expect a 20 per cent tax on your gains. Even if you hold for over a year and your gains exceed Rs 1.25 lakh, you'll still be slapped with a 12.5 per cent tax. Hence, the more you switch, the more tax you pay. That's annoying because it erodes your hard-earned returns.

Why is the stick-to-few-funds strategy better?

Consistency beats flashy winners . Funds that have the highest 20-year returns rarely top the annual charts. For instance, HDFC Flexi-cap Fund —an all-star performer in its category—gained the number 1 ranking just once in the last 20 years.

Similarly, the top-performing fund across all equity funds over 20 years has never claimed the top spot, while the leader in the Value category has done so just once. In short, long-term consistency beats short-term glamour.

Key takeaways

• Don't fall for recency bias. The glory of one year may not necessarily carry over into the next.
  
• Look for a fund's long-term track record. Choose a fund that has consistently performed over time. They're better equipped to handle market ups and downs and deliver steady returns.
  
• Opt for diversified funds like flexi-cap funds and multi-cap funds . Even large and mid-cap or value-oriented funds. Such diversified funds reduce the impact of any one fund or sector underperforming.
  
• It is best to avoid thematic and sectoral funds.
  
• Be patient. Commit to a few good funds and let compounding do its magic.

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Also read: How to make more money in 2025, and keep it growing forever

This article was originally published on January 18, 2025.