SIP Vs Lump sum – Which is better in Mutual Funds Investing?

I don’t like such questions.

Is it better to invest lump sum or monthly SIP in mutual funds?

A lot of people ask me such questions – whether SIP (Systematic Investment Plan) is better than lump sum investing in mutual funds in India? Or whether lumpsum investing is better than mutual fund SIP?

Why I don’t like these questions (are SIPs better than lumpsum investments?) is because as usual, there is no one right answer here.

There are shades of grey and it isn’t exactly an ideal comparison.

People want to simply compare SIP vs one time investment in mutual funds or just want to find out which are top mutual funds for SIP in 2019 or best mutual funds for lump sum investment in 2019 and what not. But there are no perfect answers or ready lists that predict anything.

And let’s look at it from a common-sense perspective.

Before even getting into lump sum vs monthly investment debate, the decision to invest in lump sum or SIP depends on whether one actually has enough investible surplus that can be called as lumpsum!

Right?

If one doesn’t even have this ‘lump sum’ then this question of SIP or lump sum in itself is meaningless. It’s only when this ‘lumpsum’ is actually available that the question holds any relevance.

And once the lump sum is there, the next question should be whether investing in one go is better or whether it’s wiser to spread that lump sum over a short period of time, as there can be several best ways to invest a large sum of money in mutual funds. Just because the lump sum is available doesn’t mean that the money should be invested in one go. There are can various other tactics to deploy it more efficiently.

But nevertheless, there are those who prefer SIP (and have SIP success stories to tell) and there are those who prefer lump sum investing.

And to be honest, both methods work in different set of circumstances.

Let’s try to do this comparison as objectively as possible.

SIP vs Lumpsum in Rising (Bull) Markets

In a rising market, your lumpsum investments in mutual funds will produce higher returns than SIPs. That’s because the cost of purchase in a lumpsum investment in a rising market would always be lower than the average cost of purchase in SIP, which is spread out across higher and higher purchase prices for each SIP installment.

Let’s take a very simple hypothetical example to show this.

Suppose one investor invests Rs 5000 per month in a rising market for 12 months. While the other invests Rs 60,000 as lumpsum at the start itself. Both invest in mutual funds a total of Rs 60,000. Here is how it pans out over the next 12 months:

As can be seen above, the average cost (average NAV) for the SIP investor in a rising market is higher. And hence, the future hypothetical profit when sold later, will be lower for the SIP than that of the lumpsum investor.

Now let’s look at a falling market scenario.

SIP vs Lumpsum in Falling (Bear) Markets

In a falling market, the SIP investing would result in comparatively lower losses than that in lump sum. And that is because the cost of purchase in a lumpsum investment in a falling market would always be higher than the average cost of purchase in SIP.

Here is how it looks:

As can be seen, the average cost for the SIP investor in a falling market is lower. And hence, the future hypothetical profit when sold later, will be higher for the SIP investor than it is for the lumpsum investor.

So basically what is happening is that if the market grows continuously, then lump sum investing gives higher returns whereas if it falls continuously, then SIP investing is better (lesser losses than that of lumpsum investing in such scenario).

Ofcourse in practice, the markets neither go up nor go down continuously for very long. So the actual reality may be somewhere in between the two above discussed scenarios of sip vs one time investment in mutual funds.

In some cases, SIP may give better returns than lumpsum investing. While in other cases, lumpsum will give better return than SIP investing. And in many other cases, the result of both will be pretty similar.

It all depends on the future sequence of returns that the investor gets. If you want to know how much wealth your SIP will create, try using this SIP maturity value calculator.

But let me circle back to the original point I made – whether you invest lumpsum or otherwise first depends on whether you have a lumpsum or not.

Right?

And if you have, then obviously it would be wiser to just invest lumpsum when the market is low. Remember Buy-low-sell-high?

But problem is that you will never know when the market is really low. You can be wrong about your assessment and enter at precisely wrong times.

And that said, what about our ‘real’ nature and how we behave?

Most investors are unable to use common sense when their portfolios are down.

We know that the best returns come after markets have crashed.

But very few people have the guts to go out and invest more money (assuming they have more). Fear plays a major role in investing and unfortunately, you can neither back-test emotions nor fear. And you will only know in hindsight whether is it best time to invest in mutual funds or not.

Imagine investing lumpsum in December 2007 when markets were peaking and then helplessly witnessing the fall down till March 2009. On the other hand, if you invested a lump sum in March 2009 instead (at the bottom), you would have been called the next Warren Buffett!

Both are extreme examples but show how lumpsum investors potentially expose their portfolios to the vagaries of the market. There is always the risk of being completely wrong and mistiming. And that is the problem. To be fair, one can also get the timing right and if willing to spend sleepless nights in the short term, can go on to make much higher returns than usual in medium to longer term. But that’s how the dynamics of lumpsum investments are.

Due to their structural nature, SIPs reduce this risk of being completely wrong as the investments are spread out. So asking whether is this the right time to invest in SIP is immaterial as SIP spreads out your investments. Ofcourse your returns will depend on how the markets play out during the spreading-out period. But that is how it is.

For small investors, SIP is also suitable from their cashflow perspective. They rarely have access to large lumpsum that is ‘surplus enough’ to be available for long term investing.

By putting away small amounts periodically, there isn’t a large pressure on their resources and no doubt is convenient. This is the reason that for small investors, SIP is their best bet even if not a perfect strategy.

Remember that SIP is a tool to optimize returns and match your investment needs to your cashflows. It is not a magician’s magic to generate superior returns to lumpsum investing. Read that again.

And it is for this reason that SIP is better suited when investing for long term goals like retirement planning, children’s future planning, etc.

One can use the SIP investing to slowly build up a large corpus over the years without straining the finances in present or worrying about timing the markets perfectly. You can try to use this sort of yearly SIP calculator to understand how much money you need to save for various financial goals.

I know that many of you are more focused on saving taxes.

And one popular way to save taxes these days is to go for best tax saving ELSS funds vs PPF. But there also, people tend to get confused whether to go for SIP or lump sum for ELSS when investing in top ELSS mutual funds. Nevertheless, the logic that we have been discussing till now remains the same irrespective of whether it’s an ELSS fund or a normal mutual fund.

Now let’s take a step further…

What if you have a lump sum that can be invested. Should you go ahead and invest it in one go or do something else?

Should you Invest Lump Sum In One Shot Or Systematically & Gradually?

A smart investor would recognize the market bottoming out and invest in one go. But we all aren’t smart. So if you aren’t sure if it’s the right time to invest in one go, you can even deploy your lump sum gradually.

There is no one single answer to which is the best method to invest a lump sum in mutual funds?

So depending on the market conditions, investor’s investment horizon and risk (and volatility) appetite, a deployment strategy may have to be worked out. This strategy may either aim for lowering risk or maximizing returns or a combination of the two.

One way is to put lump sum investment in debt mutual fund and gradually deploy the money using STP or Systematic Transfer Plan into an equity fund.

Different investor needs would demand different lumpsum deployment strategies.

Also, it’s important to invest in the right funds and build a solid mutual fund portfolio.

Even after the recent SEBI’s mutual fund cleanup exercise, there are still several categories and hundreds of funds out there.

Being a small investor, it can be daunting to find out which are the best SIP plans that can be considered for long term investments. Or for that matter to find out which are the best mutual funds for lumpsum investment or the best tax saving mutual funds in India or whether to do ELSS SIP or lump sum.

If you don’t know how to find good funds or need help with planning your investments, do get in touch with a capable advisor to help you. It is worth it.

Finally…

I am sorry if you did not find the one specific answer to your question of SIP or Lumpsum which is better for investing.

A direct comparison between SIP and lumpsum investing is neither fair nor accurately possible. And unless we know everything about the investor in question, one cannot say confidently which is better suited for whom.

You may feel that there is a secret to find the best time to invest in mutual funds India but there is no secret. Different investors need to follow different investment strategies for SIP and lump sum investing. And ofcourse an awareness of market conditions and how market history plays out is absolutely necessary. You can’t be blind to that.

All said and done, SIP is a comparatively safer option but we cannot deny that at times, lump sum investing will provide better returns if done correctly.

Which is better SIP or lump sum investment in top best mutual funds in 2019?

This may sound repetitive but the truth is the superiority of SIP over lump sum or of lumpsum investments over SIP varies under different conditions.

Is SIP better than one time investment? Or lump sum is better than SIP? Systematic Investment Plan vs Lump sum Investment? It is all a matter of probability and what is the sequence of returns that comes in future and how investor behaves during the period in consideration. That’s all there is to it.

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SIP may not be perfect; but it’s Small Investor’s Best Bet

If you are a mutual fund SIP investor, you would already have been bombarded with thousands of articles about why mutual funds and more particularly mutual fund SIPs are great.

And that is true.

But I wanted to re-highlight this fact in a different light.

SIP is not perfect like the theoretical (but attractive) concept of Buying-Low-Selling-High. But still, it works best for small investors and is their best bet when it comes to equity investing.

I recently wrote an article for MoneyControl on this topic. If you wish to understand why SIP isn’t Perfect but still the small investor’s best bet, then please do read the article by clicking the link below:

[Click to read] – SIP isn’t Perfect; but it’s the Small Investor’s Best Bet

Hope you find the article useful.

Picking a Fund with 15% p.a. in 10 years Or a fund with 25% p.a. in 3 years?

That’s an interesting problem.

Neither 15% nor 25% can be called as bad returns. After all, risk free rates are at 8% or even less. But ofcourse, we are greedy and we prefer higher returns. Isn’t it?

I recently wrote an article for MoneyControl titled:

‘Which fund should you choose: A 15% annual return for 10 years or 25% annual return for 3 years?’

Here is a short snippet of the article…

_________________

To be fair, both 15% and 25% average annual returns are pretty decent.

And let’s accept that the former is more achievable than the latter in the long run. At least for those who know their fund managers aren’t Warren Buffett.

But jokes apart…

_________________

You can read the rest of the article by clicking the link below:

[Click to read] – Pick an MF with 15% p.a. in 10 years Vs an MF with 25% p.a in 3 years

Hope you find the article useful.


Interview With Mid-Cap Mogul Kenneth Andrade

Kenneth Andrade Interview Midcap
Image Source: Livemint

 

I recently had the privilege of talking to Kenneth Andrade, who is widely acknowledged as one of the best fund managers in the mid-cap space in India.

Most people already know this legend and many refer to him as the ‘Mid-Cap Mogul’. Hence, an introduction is not necessary in Kenneth’s case. But for those who don’t know, he was the fund manager of IDFC Premier Equity Fund – one of the most popular and best performing mid-cap funds ever.

Ability to think out-of-the-box to identify the big theme, build investment hypothesis around it and most importantly, convert it into winning investments. This was and is his expertise. Now he has moved on from IDFC MF and turned into a private investor.

In this interview, he answers my questions about investor psychology, investing in stocks for the long term and mutual fund investing.

So here it is…

Common Investor Psychology

Dev: One of the biggest problems of common investors is their inability to sit. So how does an investor stay put even if (say) markets have moved from 10,000 to 20,000 in just a couple of years and he/she wants to book profits?

Kenneth: Investors do stay put in investments; except in equities. This probably is associated with the volatility of the asset class and the lack of a fixed return or physical asset.

Also no one likes negative returns and the equity asset class can’t promise that every year.

The western world has found a way around this with their pension plans. India still needs to get there. As a discretionary investor they will always give into greed at the top of the markets and fear at the bottom of the cycle. Hence the only way out is to package products, which eliminate or smoothen out volatility. Manufacturers in India have been experimenting with hybrids. They tend to cushion the volatility of the markets. Maybe that’s one way to keep the investor interested. It may not be the most efficient way of equity investing but the yields across market cycles would still be higher than mere fixed income products.

 

Dev: It is said that in investing, it’s very important to avoid making big mistakes. Even someone like Charlie Munger believes, that not making big mistakes is a huge determinant of whether one will have financial success in life or not.

How does a common investor identify his limitations, create a simple mental framework and more importantly, implement this framework to avoid making big mistakes?

Kenneth: The way I would address this is to invest in what you know. I am very apprehensive in putting money to work either in a company or an investment, which I don’t understand. I guess the same would apply to any investor.

One way of avoiding mistakes is to understand what you do, that way you can identify and correct it when and if it does go wrong. If you don’t know the investment, you would never know if things are going wrong in the first place.

 

Dev: What according to you is the biggest reason most investors don’t succeed in stock markets?

Kenneth: I guess most serious investors do succeed in markets. The longer you stay invested, the better are the results. Investing needs to be passive and rather than focus on prices investors should concentrate on the underlying. This is a learning process. And being persistent is the key to long-term success. A lot of investors give up in the short term.

 

Dev: How important it is for investors to have reasonable expectations? Many investors start believing that markets will continue to perform well, just because they have done so in the past. How does one correct this perception?

Kenneth: In the beginning of 2013, 10-year index returns converged with liquid fund returns. There is no set rule that equity or any asset class will deliver an above average return in perpetuity. Sure if you play with statistics, we can prove otherwise.

In the long term, any manager or fund with a return over 5%-7% (post tax) over the risk free return is a job well done. If that is the benchmark, then it is fairly important to anchor investor expectation around this number. Of course at times this could be significantly higher if a couple of asset classes do extremely well.

 

Dev: Volatility is one of the most recognizable and hated aspects of equity markets. And because of volatility, most investors do the exact opposite of what needs to be done. They buy (on fear of missing out) when markets are high and sell (out of fear), when its low. This seems to be driven primarily by the perception of volatility and risk being same things.

But that is not correct as per my understanding. So how does one start believing and also, convince others about the fact that volatility is an aspect of risk and it is not 100% same as risk.

Kenneth: I guess the latter part of the question can only be experienced with time in the market. In one of my presentations lately I made a point that you need to use volatility to your advantage. Markets overshoot in both directions, and if you take advantage of this it could be extremely profitable. But one needs discipline to take advantage of these extremities.

Mutual Funds

Dev: The best time to invest was yesterday. Next best is today. Though its easier said than done for most people (who invest for long term goals), how does one go about convincing people to stick with to long term mindset when it comes to investing?

Kenneth: It’s the discipline that’s very important for that. And more than convincing, it’s the investor experience in the product category that matters. If any consumer has had a good experience of a product or a service, chances are he will stick to that regime. So it’s important that a habit is cultivated.

A lot of investors like to see markets trend up so that their money is multiplied everyday. Logically if I had a steady income – I rather want to invest in a market that is sideways to down for even maybe 5-7 years. (Read I Pray for Bear Markets) That keeps my average holding of my investments low. Then if markets doubles or trends upwards, which they normally do once in 5 years, it’s a very profitable trade.

If you do the math investing in a market, which is trending upwards is very inefficient. You have a very high weighted average cost of holding and a relatively lower return than the former.

 

Dev: It is said that apart from returns, one should also consider many other factors while selecting a mutual fund for investing. Which factors according to you should form the key criterias for fund selection?

Kenneth: Investing in any portfolio should be a long-term commitment. Likewise the long term is also associated with durability. So if one needs to buy a MF scheme for the long term, the portfolio also needs to be in sync. There are a lot of funds out there, which promise long-term returns with the top stock undergoing tumultuous changes. Portfolio churn is never good for the long-term investor. If this were so with the underlying fund, at most the best return would be index linked. One needs to watch for this.

Stocks

Dev: Inspite of MFs being the best option for common investors*, people do get attracted by the glamor of investing directly in stocks. As per my understanding, this is human nature and people will continue to do so.

But when they do it, it also makes sense to invest only in companies, which dominate their industries with no-to-moderate debts and positive cash flows (atleast for non-professional investors, these criterias should be good starting filters).

How can an investor go about finding such companies? Another problem with finding such stocks are the perennially high valuations, which they are assigned. How does one go about investing in such companies?

* neither has the time nor expertise to analyse individual stocks.

Kenneth: MFs reduce volatility and at the same time offer participation in the growth of the capital markets. Their models are largely disciplined with managers allocating money across a number of companies. Individuals can replicate this off course by buying stocks directly. The error that most investors commit is the discipline of diversification. If this were managed well the outcomes would not be very different from diversified mutual funds.

The second part of your question resonates around investment styles. And no one style fits all. But by sticking to what you understand best will give you more upsides than downs. Don’t diversify your style.

As an investor I have always shied way from levered companies (excessive debt). And I consistently look for stocks and business that are out of favour. That way you know you are getting in at the ground floor.

An example of an ideal investment case would be a loss making company with a shrinking balance sheet in an industry that is under stress. So go one step backward on what creates capital efficiency – higher profits and capital employed (RoE = Net Profit/ Shareholder Capital). The former is the function of the environment; the latter is the function of the management. Look out for the latter, this should not be bloating. Chances are these stocks will come extremely cheap because of the cycle they are in.

As investors we all consistently focused on return. On the contrary we should be risk managers. A bull market gives you the return because all stocks participate; a manager has a very little role in that. It is the downside that counts.

You have to have a framework that works in a market offering you negative returns and measure your successes by buying companies that survive an economic slide.

 

Dev: In one of your interviews, you said that it is very important to go for companies, which are in a space that is scalable and significant. But as Graham said in Intelligent Investor, “obvious prospects for physical growth in a business, do not translate into obvious profits for investors.”

How does one think on those lines, so as to avoid the pitfalls of investing in the wrong company in the right space? Is it that the predictability of understanding the environment that a company operates in, and the ability of the company’s management to actually execute in that environment is the most critical aspect of decision making?

If yes, how does one be sure about the management here?

Kenneth: A company profit is limited by the size of its industry. Hence my fetish for scale sets in. Off course once this scale is established, the execution has to be profitable market share growth.

In my framework any company that loses market share raises a red flag, the cost of building back market share gains is ridiculously expensive. It is an easy parameter for most investors to track. (This framework may not strictly apply to commoditized business, but it works in most cases).

Getting back to the scale question, I love excesses. I always am on the look out for the next stock market bubble and the reasons that would cause it, but I would rather preempt them. Else like every one else I end up being the follower. If this is the context, I would necessary need to find scalability in the business and in the mid term markets extrapolate these numbers creating these excesses.

 

Dev: Most people say that India will continue to grow for years to come. As investors we need to be optimistic about future prospects. But as I read in one of your interviews, you said that it is very important not to go into an expanding economy with the wrong portfolio.

Most people are looking at the same set of sectors, which have done, well in recent past. But to outperform over the long term, one needs to know what can drive the next bull market. Though its tough for common investors to do it, what would you advise a person who is willing to put in place a mental-framework to think on those lines?

Kenneth: That’s an easy one. Demand creates profitability, which creates market caps which in-turn creates the need for fresh capacity. So in this framework, companies, which were growing 15%-20% per annum, set up capacities to grow between 30%-50% using near term historical numbers to justify the capital investment. This creates excessive capacities. Which is why the same sectors get very capital intensive and never return to historic levels of capital efficiency and then valuations.

If the above is true, we would need to let go of the past and look at industries where supply constraints or competitive intensity is low. Chances are they hold on to their profits and efficient capital allocation. One way of tracking this is leverage. Banks usually are arbitragers of high capital efficient business and low interest rates. They usually fund excessive creation of capacity based again of near term historical numbers, which they extrapolate into the future. So look for what these institutions fund, it may be the beginning of the next economic bubble; and excessive lending may end up being the end of one.

 

Dev: I know that you like buying companies, which are efficient with their use of capital. How can one analyse companies to find efficient use of capital. And more importantly, how does one create a list of such (prospective) companies in the first place?

Kenneth: Go one step behind. In one of the question above I alluded to two components of the capital efficiency ratio – the numerator and the denominator (ROE = PAT/ Shareholder Capital; ROCE = PBIT/ Capital Employed). The numerator is profitability, which largely is the function of the economy; I don’t believe I can predict a complex subject of growth.

The denominator however is the function of the management and efficient capital allocation. A lower denominator is all I look for and you don’t need a model to predict that. This is already in public domain. Just look for the latter. If you buy a portfolio of 20 companies that meet this criterion, the probability of going wrong is well zero!

 

Others

Dev: Few books which you would ask everyone to read, to get their thoughts about investing and money ‘corrected’ and streamlined.

And what will you suggest for someone who is interested in doing deeper analysis of the actual businesses behind the stocks?

Kenneth: I have always identified with the Peter Lynch style of investing, which is what makes his two books my all time favourites. i.e. 1) One Up on Wall Street and 2) Beating the Street

And nothing beats company annual reports if you want to deep dive into an analysis of a company.

 

Dev: How do you avoid noise and information overload, which are so prevalent these days? How does an investor focus just on what is important?

I feel that noise is generally made up of opinions people have. And I may be wrong, but most people don’t know what they are talking about when discussing about future. How does one stop oneself from becoming influenced by such noises?

Kenneth: As an investor I am always looking at a right price to buy a good business at. So noise is welcome if it gets me to that objective. Else, file all the information you get in some remote corner of your grey cells. Chances are you will need this sometime in your investing journey.

 

Dev: That’s all from my side Kenneth Sir. I thank you for taking time out of your busy schedule to answer my questions. It was wonderful to have you share your insights.

Kenneth: Thanks Dev.



Mutual Funds Vs ETFs in India – Which one to choose Today, And Which one in Future?

Note – This is a guest post by Girish Sidana, a reader and an accomplished professional working for a well-known name in Indian automobile industry. You can connect with him professional here.
 
So over to Girish… 
 
Most people reading Stable Investor would be fully convinced (even I am) that investing in well diversified Mutual Funds for a reasonably long period fetches the best possible returns. But what if I tell you that this may not remain true in future?
Yes. It may sound surprising.
 
But before I go into the details and tell you the reason for the above statement, let me try and explain the concept of another product, which is bound to play a big role in future. I am talking about Exchange Traded Funds or ETFs.
 
 
What are ETFs?
 
An ETF is very similar to mutual funds (MF) in a way, that it is also a fund of various stocks. It helps investors diversify their investment portfolio. But unlike actively managed mutual funds which charge around 2% as fund management fees, ETFs comes at a very low cost of about 0.5%
 
So how are ETFs able to charge so less?
 
Its because ETFs are not actively managed by fund managers. Rather these mimic the composition and returns provided by various indices. So you can invest in Nifty ETF which will track Nifty and will give returns commensurate to Nifty.
 
ETFs are also traded live on the exchanges. This is quite unlike MFs, which have a declared NAV for each day. Although ETFs have their own set of problems like tracking error, commission on each purchase or sale, liquidity etc., lets keep that discussion for some other day.
 
Here is what National Stock Exchange had to say about ETFs:
 
“In essence, ETFs trade like stocks and therefore offer a degree of flexibility unavailable with traditional mutual funds. Specifically, investors can trade ETFs throughout the trading day as in stocks. In comparison, in a traditional mutual fund, investors can purchase units only at the fund’s NAV, which is published at the end of each trading day. In fact, investors cannot purchase ETFs at the closing NAV. This difference gives rise to an important advantage of ETFs over traditional funds: ETFs are immediately tradable and consequently, the risk of price differential between the time of investment and time of trade is substantially less in the case of ETFs.
 
ETFs are cheaper than traditional mutual funds and index funds in terms of fees. However, while investing in an ETF, an investor pays a commission to the broker. The tracking error of ETFs is generally lower than traditional index funds due to the “in-kind” creation / redemption facility and the low expense ratio. This “in-kind” creation / redemption facility ensures that long-term investors do not suffer at the cost of short-term investor activity.”
 
Note – To know more about ETFs and how they are structured, you can read comprehensive writeups available on NSE’s website (link).
 
Philosophy of Index Formation
 
It is also important to understand how an index is formed. Let us take the example of Nifty 50. It is made of top 50 companies of India. It is a dynamic index and keeps adding and dropping companies based on their market caps and various other factors. So, essentially, Nifty 50 is a good-enough barometer of the top Indian companies.
 
Thus an ETF taming Nifty 50 will give returns of these top 50 companies of India. Logically, this should be the best possible return one can think of. What better than top performing companies and that too tracking them almost on a real time basis?
 
But historical data shows otherwise. We all know (if not all then at least readers of this website) that lots of actively managed Mutual funds in our country have been giving better returns than Nifty (or Sensex for that matter).
 
And since actively managed funds are costlier than ETFs (or index funds), the higher expense will be justified as long as active funds, after accounting for expenses are able to beat the ETFs (and index funds) by a decent margin.
 
 
What Happens in Mature Markets like US?
 
The story in markets like US is very different from that of India. In those markets, most actively managed funds are not able to beat their benchmark indices. So purely from the returns perspective, ETFs make more sense there. 
 
An actively managed fund needs to return at least 2% more than the benchmark index to come at par with ETF. Now for all of you who have understood the power of compounding, appreciating a 2% increase per annum will be lot easier.
 
The reason which I have understood (by reading expert articles on this topic), and even though I don’t agree completely, is that Indian Mutual Fund managers are able to identify hidden stocks which may not be part of an index but are value stocks. Or, to put it differently, Indian stock markets still have nuggets of Gold hidden here and there – and that is because our markets have still not matured enough. And because of this, quite a few Indian mutual funds are able to give better returns than ETFs.
 
The Question / Deduction
 
Now the big question is that as the Indian economy grows and stock markets mature, the hidden value stocks may not remain as hidden as they are now. Also, there may be very few value stocks available over a period of time. This will make the task of Mutual Fund managers a lot more difficult.
 
Based on this logic, my understanding is that in times to come, the gap between returns from an ETF and return from a MF will reduce. And once this starts happening, it will be prudent to invest in ETFs rather than MFs. Or at least it will make sense to start allocating a decent part of your portfolio to a broader ETF like Nifty ETF.
 
Again, to take the example of developed market like USA, the debate of MF vs ETF is pretty hot. The data is very much in favour of ETF but there are equal proponents of both schemes. I remember reading one of the articles which compared this debate to vegetarian vs non vegetarian. Both advocate the merits of their school of thought.
 
Although history tells us that diversified MF are best investment vehicles, the future may be very different. So it might be wise to stay on the lookout for this development and remain cautious. 
 
MF may not be the cure-for-all as it is being told to all of us.
 
Personally, I have started allocating a part of my portfolio to ETFs (apart from the regular SIPs I do in MF). Whenever I see Nifty P/E going below 22, I invest some amount in Nifty ETF. I have started doing this very recently so have not got too many opportunities. My plan is to keep doing this regularly and may also reduce my SIP amount for a given month if I see Nifty P/E going below 20 and put this money in ETF. Or even skip my MF SIP in favour of ETF if it goes below 18.
 
What do you think? Do you think it makes sense to start looking at ETFs a little more seriously in near future?
 



Power of Increasing Your SIP by 5% or 10% Every Year

A few days ago, I did a post on How You Could Create a Corpus of Rs 8.4 Crores Starting with Just Rs 10,000 every month. In the post, I analyzed following 3 scenarios over a period of 30 years (with approximate results):
  1. A Fixed SIP of Rs 10,000 every month (= Rs 3.24 Crores)
  2. An Increasing SIP, Starting with Rs 10,000 every month & 10% Annual Increase (= Rs 8.40 Crores)
  3. A Fixed SIP of Rs 26,000 every month (= Rs 8.40 Crores)

In all the above scenarios, the assumption for annual returns was 12%. Now this number, according to me is quite conservative because of the following points:

  • In last (almost) 2 decades, Indian markets have given higher returns (in excess of 15%).
  • Well diversified, actively managed mutual funds have delivered returns of more than 18% for almost a decade.
  • If risk-free instruments like NSC, PPF give close to 9% return, then there is no point going for equities as an investment class if expectations are less than 10%
  • Indian Growth Story is still intact. And till the time India becomes a developed economy, it will continue to grow at a reasonable pace. My guess is that India is still 25-30 years away from becoming a mature and (real) developed economy – in terms of quality of life, industrial might and similar things.

The last point is my personal assumption (speculation). And there were few readers who had the view that 12% average returns in not sustainable for next 30 years. Some of the views were that as the economy grows and matures, inflation would stabilize and reach levels close to 2-3% as in the case of US and other developed economies…so figuring in dividend yield and the equity return risk premium, Indian markets might give 9% to 10% return 30 years down the line… AND….Premium above inflation is bound to reduce as inflation decreases as the economy matures.

Now I am not saying that my assumption of 12% is hundred percent correct. What I am saying is that I am slightly more optimistic about India in next 30 years. I know I will not get 20% returns from market. But I ‘think’ I will be able to make more than 9% average returns over the next 30 years. Because if I am not able to manage that, then I will rather buy risk-free options like PPF, NSC, etc.

MF SIP Investing Cartoon

But more importantly, what I think a lot of people are missing in last post is the fact, that the 3 scenarios discussed show the real power of long term, sensible investing.

Ask anyone who is close to his/her retirement and chances are that they may not have crores in their retirement funds. I have people asking me questions like ‘What should I do if I have Rs 10,000 every month to invest?’ 

The previous post is an answer to that. No matter where you are and what your current financial state…you can start now!

Believe me… Equities have the ability to make you rich. Really rich… All you need to do is to be disciplined and stick to simple investment ideas.

Note that in all the scenarios, we are assuming a 30 year tenure and equity return of 12%. These numbers can change depending on change in tenure and equity return…you can either keep an assumption of 10% for next 30 years OR 12% for first 20 years and 9% for remaining 10 years. But the overall conclusion remains same – Do your SIP diligently, however small it may be. And whether or not, you are able to increase it every year. You will be positively surprised at the money you have accumulated at the end of all those years.



Case Study: How To Accumulate Rs 8.4 Crores? Starting Only with Rs 10K every Month?

Some time back, I made my 7 resolutions for 2015. One of the resolutions which I made was to increase my mutual fund SIP contribution this year by atleast 10%. This initially may seem like a simple thing to do, but believe me…it can have a really big impact on how much wealth you can accumulate eventually.

And this is what I will try to convince you about here…

Let us suppose that I stay in a job for next few decades. I turned 30 few days back. So for all practical purposes, I have another 30 years before I retire.

Let’s also assume that as of now, I do not have any savings or investments.

Now let’s take up 3 different scenarios:

Scenario 1

I start a SIP of Rs 10,000 every month for next 30 years. I am making a conservative assumption that a well diversified mutual fund scheme will be able to deliver 12% every year. There are schemes in India which have done almost double of that for almost a decade. But lets not be over-optimistic, and stick to 12% for this and other scenarios.

So after 30 years of Rs 10K monthly investment, the corpus will finally reach a cool Rs 3.24 Crores!! Details of the calculations can be found in image below. Please click to enlarge it:

Scenario 1: SIP of Rs 10K for 30 years

Scenario 2

I start with a SIP of Rs 10,000 every month. But for next 30 years, I increase my SIP contribution by 10% every year. i.e. I invest Rs 10,000 per month in first year…followed by Rs 11,000 every month in second year….Rs 12,100 in third year..and so on. Here again, the return assumptions are kept at a conservative 12%.

So after 30 years of increasing SIPs (which started at 10K a month, with 10% annual increase), the corpus will finally reach a (way cooler) Rs 8.40 Crores!! Details of the calculations in image below:
Scenario 2: SIP starting with Rs 10K, which increases 10% every year for next 30 years
So you see the difference. A simple 10% increase in your monthly SIP, more than doubles your final corpus. Not bad.

But wait…..

You must be wondering that instead of just increasing this SIP every year, what would happen if you started with higher amounts and kept it constant?

The answer to your question is provided in the third scenario.

Scenario 3

To achieve a corpus which is almost equal to one achieved in second scenario, i.e. Rs 8.40 Crores…you need to start with, and continue paying Rs 26,000 every month. Once again the detailed calculations are given in image below:

Scenario 3: Constant SIP of Rs 26K for next 30 years
As you see in second and third scenarios, you can achieve the same target amount (Rs 8.4 Cr) by choosing two different approaches. So question now is…


Which one to choose?

At first glance, it might seem that increasing SIP is better than Constant SIP as it is more convenient. It also seems to be in line with a simple common-sense based thought that:

Income Rises – Expenses Rise Too – So Should Investments

Why should SIP be kept constant when your income is rising? Your investment (through SIP) should also increase. Think for yourself… If you started a 10K SIP when you were earning 50K some years back, and you are proudly flaunting this 10K SIP even today…when currently you earn more than Rs 1.5 lac a month, then it is something stupid. You wont become rich!

An important point to consider here is that even though both scenarios result in Rs 8.4 Crores at the end of 30 years, the total investments made by you in both cases will differ substantially.

In scenario 3, the SIP is constant at Rs 26,000 for all 30 years. Whereas in increasing SIP model, you start with Rs 10,000 and it continues to increase every year. In 12th year, the SIP amount in increasing SIP scenario crosses Rs 26,000 (equal to constant SIP value).
In year 18, monthly SIP will exceed Rs 50,000. In year 26, it will exceed Rs 1 lac a month.
When you compare these numbers with constant SIP number of Rs 26,000, these might seem like very big numbers. But decades from now, these would be very small numbers considering the increase in annual income and inflation, etc.

But as I said, total investment in both cases will differ substantially. In constant SIP scenario, you will be making a total investment of Rs 93.6 Lacs in 30 years. But in increasing SIP scenario, your total investment would be Rs 1.97 Crores (almost twice!).
So does it mean that its better to start with a bigger amount in constant SIP instead of increasing one?? As in both cases…the end result is same – Rs 8.4 crores.

But before you decide, read further…

When we start investing, its not easy to allocate very big amounts towards Mutual Fund SIPs. Suppose you start earning Rs 40,000 as your first salary. You under normal circumstances, will not be able to shell out Rs 26,000 every month. But can easily manage Rs 10,000. And with rising income, you can keep increasing your SIP amounts (Scenario 2). 

Honestly speaking, there is nothing like starting a large SIP very early in your life.

What do you think? What strategies do you use to boost your SIPs?



Case Study – Combining HDFC Top 200 & Recurring Deposit – Part 4

This is the fourth and final part of the SIP Case Study which made use of HDFC Top 200 as the chosen fund. In previous post, I had evaluated the impact of considering the interest accrued on Market Crash Fund. You can read that analysis here.

In this post, I am evaluating the impact of changing the trigger point to one which is dependent on P/E Ratio of the index rather than NAV of the mutual fund (HDFC Top 200 in this case).

So after much deliberations and reader feedbacks, I came up with the following scenario to evaluate:

Scenario 1:

Investment of Rs 10,000 will be split between MF SIP & Recurring Deposits on basis of following conditions:
  • If index PE between 17 and 22, SIP=Rs 5000 and RD=Rs 5000
  • If index PE>22, SIP=Rs 0 (i.e. SIP stops) and RD=Rs 10,000
  • If index 15<PE<17, SIP=Rs10,000 (i.e. SIP doubles) and RD=Rs 0
  • If index PE<15, SIP=Rs 10,000 and RD=Rs 0; and Market Crash Fund (MCF) is utilized as follows – As soon as PE goes below 15, accumulated MCF is split into 3 parts. First part is deployed immediately and remaining two over the next two months.

Simple speaking, MCF Trigger point will be at 15PE. At this point, money accumulated will be split into 3 parts and deployed over next 3 month. SIP investments will stop if PE>22. SIP investments will double if PE<17.

The graph below shows the amount invested in SIP and amount added to MCF for all months starting 1996. I have also added the index PE for the day to show the correlation between the PE and amounts going into SIP and MF (as explained in scenario above).

MF SIP RD PE Ratio
Correlation between Index PE & SIP+RD Amount (monthly basis)

As usual, the above ‘complex’ scenario was compared with a simpler one below:

Scenario 2

Investing Rs 10,000 every month, without any regard for markets movements, PE levels or for that matter, anything.

Note – Since the chosen fund – HDFC Top 200 started in 1996, I required index PE data starting from 1996. But problem I faced was that index PE data is available starting only from 1999. Hence, from 1996-1999, I chose SIP+RD (Rs 5000 each) irrespective of index or PE levels.


Final Results of Analysis
In first scenario, the total money outgo (put in SIP, used from Market Crash Fund and money still lying in MCF) is Rs 23.1 Lacs. Of this, Rs 12.8 lac is invested as SIP, whereas around Rs 5.5 Lacs was invested in parts, at regular intervals, as and when a trigger points were reached. The money currently available in MCF is around Rs 4.8 lacs, where interest has been considered @ 8% per annum and has been calculated and added to MCF after completion of 12 months. Wherever trigger point is reached in less than 12 months, interest has been ignored for that 12 month period.

There is no change in second scenario and the entire Rs 21.8 lac is invested as SIP of Rs 10,000 every month.

I have chosen the SIP investment (& PE) dates as the first trading day of the month (whether 1st, 2nd, 3rdor 4th…)

So results are as follows:

This time, the pure MF SIP (Scenario 2) delivers Rs 2.46 crores. And a combination of SIP+RD (Scenario 2) delivered Rs 2.47 Crores. If we were to include the money currently available in MCF, it would be Rs 2.52 Crores.

SIP Vs RD Monthly
Scenario 1 & 2 Comparison

So…let see what it means…

It might seem that SIP+MF combination has beaten the pure SIP this time. But in reality, it’s not true. Why?

I have not considered the penal charges & tax implications of liquidating the MCF (via RDs). Though it might not be significant, it still brings down the returns over a period of almost two decades. Another thing to note here is that I have considered interest on RD as 8% calculated yearly. This itself can fluctuate depending on prevalent interest rate scenarios during the last 20 years.

But most importantly, this outperformance of Rs 1 lac (or Rs 6 lac if you consider the accumulated MCF), requires you to monitor PE ratio all through these 20 years and be ready to calculate how much to invest (if PE breaches 15 on lower side or 22 on upper side) every month. Also the charges of starting / stopping RD, and for that matter SIP is also something which needs to be taken into account.

By the way, if you are interested in having a look at the exact numbers, click on the image below:

MF SIP and RD Analysis Since 1996
Full Analysis

Final Comments

So this analysis has once again proved (like previous parts 1, 2and 3) that, for average investors, it is more than enough to continue investing as much as possible every month in a good diversified mutual fund. They should not pay much attention to ups and downs of markets and whether markets are overvalued or undervalued. No need to put your money regularly in a Market Crash Fund (MCF) solely for purpose of investing in MF when markets are down.

PE Ratio of Index & Amount Accumulated in Market Crash Fund

But if you are lucky to have some surplus funds when markets are trading at low valuations (around PE15), then make it a point to invest. Don’t be afraid. People around you would try to convince you not to invest. They will try to tell you that markets will go down further. Please don’t listen to them. Even if it goes down (even upto PE12), remember that it will soon revert back to mean (17-18) and then you will be happy that you invested during the downtimes.


What Will I Do?

Personally, I do maintain a Market Crash Fund (MCF) which is funded by interests, dividends and any surplus income which I generate. And I use this fund for buying direct stocks (as and when I feel that stocks I like, are trading at low valuations). I generally don’t use this MCF for MF investments.

So what will I do going forward? 

The above analysis clearly shows that there is not much point in taking such an approach. And that is because the additional returns generated by this approach do not justify the efforts put in last two decades. But when not buying individual stocks, I might still use my personal MCF to buy MFs in lumpsum. But I will do it only when I am not absolutely sure of which stocks to buy… but I am pretty sure that markets are grossly undervalued and should be invested in.