Mutual Fund Underperforming: When to Worry and When to Wait

A mutual fund underperforming its benchmark for one year is usually not a verdict, since even well-run funds lag in some periods. A fund that trails its benchmark and category for several years in a row deserves a closer look. Judge the gap over rolling periods, weigh the cost of switching, and only then decide.

Compare against the benchmark and the category

A fund's return means little on its own. Measure it against two yardsticks. The first is the benchmark, the index the scheme is designed to track or beat. The second is the category, the peer group of funds that share the same SEBI mandate.

Suppose, for illustration, a fund returns 9% in a year when its benchmark returns 12% and its category averages 7%. It has lagged the index but beaten most of its peers, which may point to a hard year for that style of investing rather than a problem with the fund.

Rolling periods show the trend

A single start and end date can flatter or punish a fund. Rolling returns measure performance across many overlapping windows, such as every one-year period over the last five years. A fund that trails its benchmark in most of those windows has a real pattern. A fund that trails in only one window may simply have had an unlucky start date.

Mutual fund underperforming once versus every year

Two patterns look similar on a one-year screen but cost very different amounts over a decade. Suppose ₹10 lakh is invested for 10 years. The benchmark is assumed to return 12% every year. Fund A matches it for nine years and earns 6% in one year. Fund B lags by 2 percentage points every year, so it earns 10%.

Illustrative figures at assumed returns. Lump sum of ₹10 lakh, before tax.

The bad year costs ₹1.66 lakh. The persistent lag costs ₹5.12 lakh. A single weak year is a question to ask, not a verdict, while a small lag that repeats every year is the pattern that compounds against an investor.

Fund versus benchmark over 1, 3 and 5 years

Short windows exaggerate gaps. The table below shows a lump sum of ₹1,00,000 at assumed annualised returns for the fund and its benchmark over three periods.

Illustrative figures at assumed returns on ₹1,00,000, before tax.

The one-year gap is larger because the assumed returns differ by six percentage points. Over five years the assumed returns are only half a point apart, and the rupee gap is ₹3,830. The period you look at changes the story, so compare across several periods before concluding anything.

The cost of switching a fund

Selling to chase a better fund has its own price. Exit load is a charge deducted from the proceeds when you redeem within a period set by the scheme. Tax is due on the gain when you sell. Both are shown below for two illustrative holdings.

Illustrative. Units bought for ₹4,00,000 and ₹5,00,000 respectively. Exit load assumed at 1%, though loads vary by scheme. Tax shown before surcharge and 4% cess, assuming no other gains that year, for units sold on or after 23 July 2024.

Within 12 months, the gain is taxed at 20%, so the switch costs 5.0% of the holding's value. After 12 months, the gain is taxed at 12.5% above ₹1.25 lakh a financial year, and the same kind of switch costs 2.73%. The holding period matters as much as the choice of fund. Switching from a Regular to a Direct plan of the same fund works the same way, since it is also a redemption and a fresh purchase.

Signs that justify a closer review

A lag alone is a reason to look, not to sell. These signs suggest a closer review:

• The fund trails its benchmark and category across most rolling windows over three to five years, not just one.
• The fund manager has changed, and the lag has continued since.
• The portfolio has drifted away from the category's rules or from the role you gave the fund in your plan.
• The expense ratio has risen, which adds to the gap every year.
• The scheme itself has changed. Under SEBI's 2026 recategorisation, some schemes were required to update their names, objectives, strategies or benchmarks. Check whether the benchmark you compare against is still the same, using the SEBI 2026 recategorisation guide.

Making the decision calmly

Write down the reason before any switch. A fund that lags because its mandate changed is a different case from one that lags with no change at all. Next, check the tax and exit load, as in the table above, and compare the candidate fund against the same benchmark and category. If the gap is persistent and the cost of switching is small next to the difference you expect, a switch may make sense.

If the lag is one bad year, waiting usually costs less than switching. Review the fund at a set interval, and use the guide on when to sell a mutual fund if the signs above begin to appear. For how to read a fund's history properly, see how to check a fund's past performance.

Frequently asked questions

How long should I wait before judging an underperforming fund?

Three to five years is a more reliable window than one year, because equity returns swing widely in the short term. Look at rolling periods within that window, not only the most recent year. If the fund has trailed its benchmark across most of them, the lag is probably a pattern rather than bad luck.

Is one bad year a reason to switch?

Usually not on its own. A single weak year can come from one sector, one phase of the market or an unlucky entry date. Check whether the fund still follows its stated mandate, and remember that switching can cost tax and an exit load today, which a short-term lag may not justify.

Does switching to a better-performing fund always help?

Not always. A fund that has recently outperformed may have done so because of one period or one style, and that can reverse. Compare the candidate over rolling periods against its own benchmark, then subtract the tax and exit load of selling your current fund from any expected gain.