We have said it before, yet we take the occasion of the approaching New Year to say it again: Investing in equity is not about the markets moving up or down, but about picking good quality companies and remaining invested for the long term. What can aid this is systematic investing through systematic investment plans (SIPs) in mutual funds (MFs) as well as direct stocks.
In February this year, Mint Money ran some data to analyze the effectiveness of SIP (MF) in smoothening out volatility over a period of time. At the start of 2012, one-year equity returns weren’t looking good and over five years, investors were just about breaking even. Nevertheless, our analysis showed that in the medium term SIPs smoothen out volatility and in the long run, say 10 years, compounded annual growth rate or CAGR for this investment is in the range of 20-25%. It is good to remind ourselves of this kind of long-term track record when markets aren’t doing well and you have lost faith.
But now that things have picked up and market barometers, the BSE Sensex and CNX Nifty, have rallied around 20-25% in the last one year, is it time for you to start making big investments in equity or stick to SIPs?
The case for MF SIPs
There is enough historical data to show that in the long run equity delivers double-digit returns, which is more than enough to cover for inflation eating into your money. Indian equities have returned 19% and 11% CAGR in the last 10 and 20 years, respectively. But lump sum investing has an element of market timing, which if you get wrong can make your stomach churn. Say you invested a lump sum in the market five years ago, most likely you would be making losses or at best break even; if you made it six years ago, your CAGR would be around 6-7% and if you had made it a year ago, then your annual return would be around 20%. From January 2008 till December 2011, the Sensex corrected 21%, then rallied 11% till March 2012 and then again fell 10% before rallying 20%. Now that is quite a roller coaster ride and your experience will depend on the point you boarded the ride.
The job of an SIP is to remove the ambiguity that market timing brings to the table. You simply invest a fixed amount every week, month or quarter in an asset you know will perform over a period of time despite the volatility caused by daily news and events. If the market is trending higher in a given period of time, lump sum investing will always look better than SIP when you compare investing from the start of the period till the end. But what if you started somewhere in the middle and put in a lump sum when equity markets were at a peak? It’s highly likely that returns may be low single digit or even negative today.
Historical data gives SIP a thumbs up: We looked at returns for top equity MFs by assets under management (across large-, mid- and multi-cap categories) and found that while 10-year lump sum returns (where available) are 5-10% better than SIP returns, in case of five-year returns, SIPs score better (see graph). What this shows is that in the long run SIPs are more stable in delivering returns and at the same time don’t take away from the potential high returns attributed to equities in the long run.
Key lies in remaining invested: One-year returns look good today, but in December 2011, the story would have been very different as one-year returns then would have been in the range of -20% to -25%. But 10-year SIP returns would have still been in the 20-25% range if you had done the same analysis in December 2011. That’s a smooth ride with no confusion.
Says Sumeet Vaid, founder and CEO, Ffreedom Financial Planners, “The only way to reap benefits (from equity investing) is to keep emotions aside and remain invested despite ups and downs; this can be done by adopting a goal-oriented approach.”
Discipline works for direct equity too
Let’s say you invested Rs.100 in Hindustan Unilever Ltd at the start of every month in the last five years. Your total investment of Rs.6,000 would be worth Rs.13,408 on 20 December 2012, a CAGR of 14.5%. A similar investment in Tata Consultancy Services Ltd would have yielded 16.7% CAGR and in Tata Motors Ltd around 17% CAGR. In this period, the Sensex moved -0.4%, which is a CAGR of -0.08%.
Investing directly in equity shares works if you know what you are doing. You need to understand the fundamentals of a company, analyze its financial health and management capability and then take a long-term call. Once you have identified these stocks, using the SIP service your broker offers makes sense because stock prices in the short term are influenced not only by company fundamentals but more by market news and events. Says C.J. George, managing director, Geojit BNP Paribas Financial Services Ltd, “In the last 18 months, we have added 100,000 investors in SIP and not one of them has lost money. That is a great track record and tell other clients as well to invest in a disciplined manner.”
While some of you are already using this, it’s not a favourite with investors yet. Investor attention is more focused on derivatives, which contribute 80-90% of daily market turnover. Says Sudeep Bandyopadhyay, managing director and chief executive officer, Destimoney Securities Pvt. Ltd, “SIP has not been much of a success as market was lacklustre and retail investors by and large stayed away. In this time for many individual investors’ options as a tool has worked.”
What should you do?
You will miss out on returns if you don’t invest in equity via SIP. There are few other avenues which will consistently give you around 20% CAGR over a 10-year period. Unless you have the wherewithal to analyze individual equity stocks or have an adviser who can do this for you, stick to equity MFs.
Vaid says investing is not so much about looking at what the markets are doing, rather it has to do with what your long- and medium-term financial goals are. He says, “If you can articulate and quantify your financial goals, it will bring discipline to investing and help achieve long-term returns. An adviser will manage emotions and investments rather than predict the market movement.” So choose your SIP based on what you want your money to achieve.
Lastly, an important question is when to exit? After five years or 10 years? And five-year returns today can be very different from five-year returns a year later. Once again the trick is to focus on financial goals and as Vaid suggests shift from volatile investments to more stable avenues as you come closer to your goal.
In 2013, resolve to keep things simple—keep investing at regular intervals to maximize your long-term returns from equity, while minimizing volatility.