During a recent reunion of school friends, I happened to interact with one of my close friend about his personal finance. He mentioned that he had started to invest in equity markets through mutual funds route since 2015. It was heartening to see that being a novice into equity investing; he had made a right choice of mutual funds instead of direct equity. He seemed to be extremely happy with the performance of his investments. However, what made me worried about his approach was the impression that investments through SIP can never fail. Post about a week of our initial discussion, I shared with him some facts and findings about SIP investments. I am reproducing the same for the benefit of one and all (especially the new investors in mutual funds).
In order to evaluate this, let us first analyze annualized Sensex returns from 1990 to 2015. The rationale for choosing this period was to see the impact of several market cycles, i.e. bull and bear market to rule out any market cycle related bias. The chart below shows the annual closing values of the Sensex from 1990 to 2015:
Source: Bombay Stock Exchange
It is interesting to note that in this long period of 25 years, sensex has moved from around 1,000 to 25,000. For the purpose of my analysis, I used the following chart to understand the annual returns of Sensex.
The highest annual return of the Sensex was 80%, but the lowest annual return is -60% losses (in 2008). This shows the volatility of the market. The average annual return of the Sensex over these 25 years was around 19%. Standard deviation of returns which is used to measure the volatility was 35%. You can see in the above graph that returns have dipped below “Zero” on 6 occasions.
In order to understand the impact of duration on returns, let’s now look at the following tenures of annualised rolling returns of Sensex since 1990.
1. 5 years tenure: The following graph shows 5 years rolling returns of Sensex:
The findings for 5 years rolling returns vs annual returns are quite interesting. The standard deviation of 5 years rolling returns of sensex is at 12% (compared to 35% with one year investment tenure).
2. 10 years tenure: The following graph shows 10 years rolling returns of Sensex:
Note that the rolling returns for a period of 10 years of investments never went negative and in fact were much above the rate of inflation in most of the time period. The standard deviation of 10 years rolling returns of Sensex was only 5%.
3. 15 years tenure: The following graph shows 15 years rolling returns of Sensex:
It is very clear from the above chart that the risk of investing for a period of 15 years is much lower. The standard deviation of 15 years rolling returns of Sensex is only 2%.
Looking at the above graphs for various tenures, I am tempted to say that the rolling returns over 15 years of investment period is almost predictable, but I will not because it is incorrect to say that the equity market is predictable.
Let us now look at the performance of SIP investments made between the period of 2004 – 2015. For the purpose of this analysis, I have assumed the following:
a. Scheme Types: Broadly 5 scheme types have been selected as per the table below
b. SIP Amount: INR 10,000 per month
c. SIP Date: 07th of every month – starting from Feb 2004.
d. Fund House: Same fund house across all categories
Let us now look how the returns have fared for various tenures of investing:
You can see sharp fall in returns during the 5 year tenure period for equity oriented funds – Balanced Fund, Diversified Equity and Large Cap Fund. This is the period of bear run of 2008-09. During this period it is very clear that equity oriented mutual fund schemes have failed miserably. It is very important to highlight here the fact that almost all investors would consider a period of 5 years to be a “Long Term” period. This would have created havoc for people who would have been nearing the end of their goal period. The facts shown in the above chart should however, not be interpreted that SIP shall under-perform during 5 year period. It is not possible to forecast the market performance levels every time accurately. This requires constant monitoring and restructuring, failing which investments in SIP may fail. One shall continue investments in SIP even during bear market scenario if his/her goal period has time to mature. This shall give good chance to accumulate more units and shall help in lowering the average costs of units held to avoid the chances of SIP failure.
With the help of combination of certain techniques/strategy like asset allocation strategy, monitoring of certain indicators like rolling returns, standard deviation, sharpe ratio, etc one can come up with risk management strategies to contain the amount of drop and protect the appreciations made in the invested amount.
Conclusion: Investments in mutual funds requires lot of factors to be considered before making a choice. Time frame of goal, risk appetite of investor, investment objective of the scheme, etc are some of the factors which require consideration. Further, it is a continuous process of monitoring the progress made vis-à-vis the identified goal of the investor.
Managing one’s investment is like nurturing a child. One needs to keep a constant eye on the progress made. We at K&R Planners help you to plan and see your investments grow!
Note: This article is being published with the intention of investor education purposes only. This shall not be construed as promotion/solicitation of any financial product.