SIP, Expectations and Reality

Indian’s have generally been Risk Averse and that is seen in the percentage of assets an average household has invested in markets (Direct or Indirect). Real Estate on the other hand has had huge amount of backing given the rally we saw in the last decade. But with Real Estate prices shooting for the moon and one which is affordable by a very small segment of population, investors are now turning towards equity in an attempt to get returns that are better than Inflation.

Mutual Funds in India has been as old as the hills with plenty of funds being launched by Unit Trust of India since the 1960’s. While the Asset under Management has been growing in time, given the growth in economy, it was still a lagger.

While Mutual Funds have all sorts of schemes, for the retail investor, most funds recommend Equity since only Equity has ability to provide for positive returns after adjusting for Inflation. And then there is also the small thing about being able to extract a higher fee from equity than from Debt.

In recent times, we have witnessed funds going all out in attempting to push investors into embracing equity investing through SIP’s. In this blog itself, I have written enough on the Pro’s and Con’s, so I will stay away from the same.

Today, lets talk about the term Equity Risk Premium. Investopedia defines it as under;

Equity risk premium, also referred to as simply equity premium, is the excess return that investing in the stock market provides over a risk-free rate, such as the return from government treasury bonds. This excess return compensates investors for taking on the relatively higher risk of equity investing.

Its effect is better seen if you were to compare Nifty Total Returns (the benchmark I like to use) vs a Liquid Fund (SBI Magnum Insta Cash Fund).

As you can see, its really one sided with Nifty Total Returns beating the Returns of the Liquid fund hands down. But that is the reward. What about Risk?

Liquid fund has no draw-down. Every day is a high day and you cannot get a better picture than by seeing the chart of the fund. In other words, at no point of time is the value of your investment lower than what you have invested.

Equity on the other hand provides no such guarantees. As any investor who invested in late 2007 can tell you, at the depths, you wonder if you have lost everything you have invested even though you may have invested in a Index rather than individual stocks (where such risk definitely exist)

At multiple points in time, you had 40% or more of falls from peaks and this is Risk that you, the Investor is willing to carry for the +ve returns you hope to get.

But how much extra do you really get? To get to that answer, I used Nifty Total Returns and subtracted the returns of the Liquid Fund. Results are as here under;

(Click on the table to expand if you cannot view data for all 17 years).

What does the above table tell you, especially the row that I have color formatted (Median Returns)? Do note that the data is not adjusted for Inflation.

SIP is a excellent way to save money, but is it the best way to invest in markets given the near uniform distribution of returns? Good Friend, Kora Reddy the other day tweeted (read from last to first),

The data in the table I presented above is more of a synthesis of what Kora tried to put up.

If you invest in a SIP and can do so for more than 10 years, you really start to see the benefits start to show up.

But once again, there is the question of whether the fund you choose to invest will be able to beat the Index over the next 10 years. If you were to look at data that is publicly available, the percentage of funds that have beaten Index is very high at the 10 year mark (due to Survivor bias effect) and keeps coming down year upon year.

These days, most SIP’s have option to invest for perpetuity and hence if you can hold onto your behavior when markets crack next time around (and hold onto your Job as well) and if you have chosen the right fund, you may be happy with what you have achieved once markets come back (as has happened ‘n’ number of times in the past).

But money has a utility value and if you need that money when markets is not at its best (its all correlated – market falls / job loss / health issues – everything happens at the worst possible time), you know whom to blame, or do you??