A few weeks ago, a client sent me a screenshot. It was a chart of a fund that had delivered impressive returns over the last three years. The numbers looked mouth-watering. The message was simple: “Why don’t we have this in my portfolio?”
We spoke. I explained cycles. I explained diversification. I explained that trailing returns often look the best just when enthusiasm is at its peak. He understood. He agreed.
A few weeks later, markets corrected. His diversified portfolio showed a temporary decline. Another message arrived. “Is something wrong?”
Nothing was wrong. Except something very normal was happening. Volatility.
What makes this pattern interesting is that the investor is no longer new. It has been more than five years since the COVID crash. He has already experienced a sharp fall, a dramatic recovery, and strong rallies after that. In theory, this should have built comfort.
In reality, something else happens. After one or two strong years, trailing three-year and five-year returns begin to look attractive again. Charts look smooth. Compounded numbers look convincing. And slowly, comparison begins to replace conviction.
This is when diversified portfolios begin to look ordinary. And in markets, ordinary often feels like underperformance.
The Paradox of the High Return Seeker
Over the years, I have realised something paradoxical. Many high-return seekers are actually short-term risk-averse investors. They want 18–20% compounded returns. But they do not want ranking fluctuations. They want strong performance. But they do not want phases of underperformance. They want alpha — without discomfort.
The reality is that high returns are not delivered in straight lines. They are delivered in phases. A strategy that produces superior long-term outcomes must necessarily pass through temporary periods when it does not look superior. If it did not, it would likely be taking a hidden concentration risk.
I remember a phase before 2020 when a client was frustrated with active large-cap funds. The index was rising sharply, but active schemes were lagging. He questioned the structure itself. Why can’t fund managers increase allocation to the top-performing stocks? Why operate with such limitations? (Also Read: The wisdom of deciding less)
At that time, indices like the NIFTY 50 had become heavily concentrated in a handful of stocks. Because it is market-cap weighted, an index automatically increases exposure to stocks as their prices rise. Concentration builds mechanically. Active funds, however, operate under diversification and exposure norms prescribed by the Securities and Exchange Board of India. They cannot allocate disproportionately to a single stock beyond regulatory caps.
In a narrow rally, concentration wins. In a broader rally, diversification participates. After 2020, when participation widened and different sectors recovered, active funds performed strongly. The narrative changed.
Nothing was structurally broken earlier. Nothing became structurally superior later. The cycle simply turned.
Value investing offers another example. There were years before the pandemic when value strategies were considered outdated. They lagged growth-oriented portfolios significantly. Doubts surfaced. Questions increased. Post-pandemic, value made a comeback. The same strategy that was doubted began to look wise. The strategy did not reinvent itself dramatically. Market leadership changed.
Every strategy looks broken before it works and obvious after it works.
Research says this all
Behavioural research has long explained why we struggle with this. In their 1979 work on Prospect Theory, Daniel Kahneman and Amos Tversky demonstrated that losses hurt roughly twice as much as equivalent gains feel good. Even temporary declines feel disproportionately painful.
Later research by Richard Thaler and Shlomo Benartzi on myopic loss aversion showed that the more frequently investors evaluate their portfolios, the more conservative they become. Frequent observation magnifies short-term fluctuations. Fluctuations increase perceived risk. Perceived risk triggers action.
And action, in investing, is often expensive.
When portfolios are shuffled frequently based on trailing returns, the costs are not always visible immediately. Exit loads may apply. Capital gains tax becomes payable. Long-term holdings get reset to new clocks. Transaction costs accumulate. Compounding, which thrives on continuity, gets interrupted. The irony is striking. In the pursuit of higher returns, investors sometimes reduce the very returns they are trying to enhance.
The long-running DALBAR “Quantitative Analysis of Investor Behaviour” studies have repeatedly shown that the average investor earns lower returns than the funds they invest in. The gap arises not because funds fail, but because investors buy after strong performance and reduce exposure after weak phases—the fund compounds. The investor interrupts.
Experience Changes the Meaning of Volatility
Experience changes this behaviour, but not because it makes one smarter. It builds memory. Experienced investors have seen multiple cycles. They have seen growth dominate and cool off. They have seen small caps surge and then struggle. They have seen funds move from top quartile to the bottom and back again. They carry emotional memory, not just numerical data.
First-cycle investors carry spreadsheet memory.
Over time, I have come to realise that my role is less about identifying the next outperformer and more about protecting a well-designed process from being abandoned mid-cycle. Diversification will look unnecessary when one theme is shining. Discipline will look slow when concentration is winning. Patience will look foolish when excitement is rewarded.
But compounding does not reward excitement. It rewards endurance.
A Personal Reflection
Some of the calmest investors I work with today are not necessarily the most knowledgeable. They are simply the most experienced.
They have seen markets rise, fall, disappoint, recover, and surprise them repeatedly. Somewhere along the journey, they stopped expecting linear outcomes.
They no longer chase the best-performing fund every year.
They allow time to do its work.
Perhaps true risk tolerance is not revealed during rallies, but during phases when conviction is tested without immediate reward.
Moral of the Story
Seeking high returns is natural. Markets exist to create wealth.
But sustainable investing rarely comes from constantly pursuing what performed best yesterday.
Long-term success belongs less to those who find the perfect investment and more to those who develop the ability to remain invested across imperfect phases.
Because in investing, the real advantage does not come from predicting cycles.
It comes from surviving them — patiently enough for compounding to eventually speak.
And perhaps that is the quiet lesson markets keep teaching us — not which fund will win next, but whether we can remain steady long enough to benefit from the one we already chose.
