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Behavioural biases that quietly drain mutual fund returns

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Behavioural biases that quietly drain mutual fund returns

2026-08-02 09:08 UTCBy AlphaScala Research DeskSource reporting: livemint.comEditorial standards

Behavioural biases that quietly drain mutual fund returns

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Recency bias, loss aversion and herd mentality create a gap between fund returns and what investors actually earn. Experts explain the traps and how to avoid them.

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Mutual fund investors spend time picking the right scheme, yet their own behaviour often hits long-term returns harder than the fund itself.

Financial experts say psychological biases prompt investors to buy after rallies and sell during corrections, creating a gap between what a fund earns and what investors actually get. Behavioural finance calls that the "behaviour gap."

According to Protima Dhawan, Director & Unit Head at Anand Rathi Wealth Limited, recency bias explains much of the gap.

"Investors tend to chase whatever has performed well recently, entering only after a large part of the rally has already played out, assuming the same pace of growth will continue," she said.

She points to the recent gold rally. Between March 2024 and March 2026, gold prices rose nearly 117%. Around 75% of all Gold ETF inflows came only after gold had already gained about 72%. While gold more than doubled during the period, the average investor earned an absolute return of only around 23.5%.

Rhishabh Garg, CEO of FundsIndia, said recency bias is one of several behavioural mistakes that hurt long-term returns.

"Investors chase what has done well recently and exit what hasn't, often leading to buying high and selling low," he said. Herd mentality, fear of missing out and overconfidence further hurt returns by encouraging frequent fund switches or market-timing attempts, Garg added.

Madhu Lunawat, Founder, Managing Director and CEO of The Wealth Company, believes the problem is wired into human psychology.

"Our brain was never wired to make us rich. It is wired to keep us safe. That is why we sell when markets fall and buy when markets are already up," she said.

She added that investors often assume last year's winning asset or fund will keep outperforming, causing them to invest after the rally and exit after the correction.

Loss aversion is another major trap. Investors feel the pain of losses more strongly than the satisfaction of gains, leading to emotional decisions during market declines.

Dhawan cites the March 2020 correction. When the Nifty 50 fell 23% in a single month, inflows into small-cap mutual funds dropped by 89%, even though valuations had become significantly more attractive. The Nifty Smallcap 250 Index went on to deliver around 105% returns between March 2020 and December 2021.

Lunawat said investors often abandon long-term financial plans because short-term declines feel like immediate threats.

"A twenty-year plan turns into a decision made in twenty minutes," she said.

Experts say the most effective way to reduce behavioural mistakes is a disciplined process rather than reacting to short-term market moves.

Dhawan recommends sticking to a long-term strategy, continuing SIPs during market corrections and avoiding investments based solely on recent performance rankings. She noted that since 2001, the Nifty 50 has witnessed an average peak-to-trough drawdown of around 18% every year. Market corrections are normal, not a signal to exit.

Garg advises automating investments through SIPs, defining financial goals and investment horizons in advance, reviewing portfolios periodically instead of daily, rebalancing on a fixed schedule and avoiding chasing recent top-performing funds.

Lunawat suggests a "24-hour redemption rule." Before redeeming a mutual fund, investors should write down why they want to sell and wait 24 hours before acting.

"If the reason still makes sense the next day, go ahead. If it was just fear after a market correction, you have probably saved yourself from a very expensive mistake," she said.

She also recommends writing down the reason for an investment before making it and referring to that note before redeeming. Measuring progress against long-term goals instead of daily NAV movements can help avoid emotional decisions.

"The investors who create the most wealth are often those who let their emotions interfere the least," Lunawat said.