What do you worry more about? Your existing corpus or the next SIP installment?
Many of us spend a lot of time finding the “Best mutual Fund” to start Systematic plan in. Very little time is devoted to review/re-balancing of the existing portfolio. Is that the correct approach?
By the way, there is nothing wrong with trying to find out the best mutual fund to invest in. That the task, in itself is not so simple, is a different matter altogether. However, does your research effort be only directed towards your fresh investments? What about the already accumulated corpus?
In my opinion, you need to take greater care of your existing portfolio, especially if you have investing for a long time.
Let’s try to understand with the help of an example.
Suppose you are 30 and plan to invest Rs 10,000 per month for 30 years for your retirement. Let’s assume equity mutual fund is the only asset available for investment.
After one year, you have invested Rs 1.2 lacs (Rs 10,000 per month X 12 months). Suppose your investment has grown to Rs 1.3 lacs at the end of 1 year. Now, the next investment of Rs 10,000 is 7.69% of your existing investment corpus. In the next 1 year, you will be investing Rs 1.2 lacs, which is almost equal to your existing corpus of Rs 1.3 lacs at the end of 1 year.
Hence, the incremental investment is significantly large percentage of your existing portfolio. Needless to say, you must get your investment choices right because the incremental investment is a significant portion of your existing corpus.
Fast forward 20 years.
Let’s assume your retirement corpus earns a return of 10% p.a. If you continue the same rate of investment, your retirement corpus would have grown to Rs 76.56 lacs at the end of 20 years. Now, the incremental monthly investment is only 0.13%. 1% of Rs 76.56 lacs is Rs 76,560. Even the incremental annual investment of Rs 1.2 lacs is only 1.57% of your existing corpus. A good or bad day in the market is likely to move your existing corpus by greater than Rs 1.2 lacs. This means you will lose or gain an amount greater than or equal to next year’s investment in a single day.
Now, should you be focusing more on managing your existing corpus or be worried about where your next SIP installment should go?
Through my interaction with limited number of clients, I have seen that the focus is more on fresh investments. They do not share equal concern for existing investments. For some reason, fresh investments get disproportionately greater attention than the existing investments.
This, to me, is quite bizarre. The part reason is that most of them have existing investments in safe debt instruments such as EPF/PPF, which provide almost guaranteed and fixed returns. Hence, there is not much to tinker around with.
In my opinion, it is important to review and rebalance your existing portfolio when the portfolio is bigger. More so when you are closer to your retirement (or in early years of retirement)
Let’s consider two examples. You invest Rs 10,000 per month for 30 years in both cases.
- You earn 6% per annum for first 15 years and 12% for the next 15 years.
- You earn 12% per annum for the first 15 years and 6% for the next 15 years.
Yes, the assumption about return is unrealistic but helps me drive home a point.
Under case (1), you will end up with Rs 2.26 crores at the end of 30 years. Under case (2), you will end up with Rs 1.53 crores. Quite a big difference, isn’t it? Do note long term average return is same in both the cases. Yet, the amount is almost 50% higher in the first case.
This can entirely be attributed to the sequence of returns (long term average growth is same in both the examples).
Why such big difference?
This is because in case (1), a bigger corpus earned better returns (12%). In the second case, the good returns came when the corpus was quite small.
Moreover, out of Rs 2.26 crores in the first case, Rs 1.75 crores (or 77% of the final corpus) is from the investments in the first 15 years and the remaining Rs 50.5 lacs (or 23% of the corpus) is from investments in the last 15 years. This is despite earning double the return in last 15 years.
In the second case, out of Rs 1.53 cores, Rs 1.23 crores (or 81%) is from investments in the first 15 years while the remaining 29.2 lacs (only 19%) is from investments made in the last 15 years.
Yet, you are more worried about the next SIP installment.
Don’t you think it is important to worry more about the existing corpus?
Don’t just focus on your fresh investments. Existing investments are more or at least equally important. This is especially true for larger portfolios.
You need to review and rebalance your portfolio at regular intervals in line with your goals. Try to reduce portfolio volatility as you approach your goal.
Choosing the right funds and figuring out the best time to invest is still important. However, do not ignore your accumulated corpus.
Additional aspects that you must be aware of:
- Sequence of returns is extremely important. And you do not control the sequence of returns, at least with volatile asset classes. It is sheer luck. Many advisers/planners may hate to use the word but it is true.
- Asset allocation/rebalancing and rupee cost averaging can help tide over market volatility to an extent during accumulation phase (before retirement). You may need to manage volatility actively as you approach retirement.
- Sequence of returns is even more important during retirement (decumulation phase). A poor string in the initial years of retirement and your retirement planning can go for a toss. Rupee cost averaging works in reverse fashion in a decumulation portfolio (portfolio you are using to make withdrawals). You have to withdraw at an increasing higher rate from a depleting corpus to maintain a level of income. Asset allocation and rebalancing won’t be much help. More on this in another post.
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