You cannot go wrong with mutual fund SIPs. Can you?
Just start a SIP and forget about it. Good returns are guaranteed.
Anecdotes are fine. What does the data tell us?
Does SIP guarantee good returns?
I consider 3-year, 5-year, and 7-year SIP returns on Nifty 50 TRI for the last 20 years.
I have considered a large-cap index (Nifty 50 TRI). A holistic exercise should have been performing this exercise for the entire category but that is a bit of work. The good part with the Nifty 50 TRI is that it is a formidable benchmark to beat, at least for the actively managed large-cap funds. I agree that some active funds will beat this Nifty 50 TRI while others will lag the benchmark. However, this exercise will give us a fair idea about what to expect. Note that the results will be different for other indices or other categories of funds.
I consider SIP instalment of 1st of each month. If the markets are closed on 1st, then the instalment goes on the next working day.
For a 5-year SIP, the plot of July 1, 2008 indicates the return for SIP for 60 months starting on July 1, 2003 and ending on June 1, 2008.
Similarly, for a 7-year SIP, the plot of July 1, 2008 indicates the return for SIP for 84 months starting on July 1, 2001 and ending on June 1, 2008.
I could have considered SIP starting on each day of the money and compile the results. Yes, that would have been more robust, but this analysis gives a fair idea in my opinion.
How do the Nifty 50 SIP returns look like?
Let us first look at the rolling returns. These are annualized returns.
You can notice that a 3-year SIP can give negative returns
In fact, towards the end, in 2020, you can see that even 5-year SIP is in the red. 7-year SIP is just above zero.
However, you invest in equity funds not just for positive returns but for good returns. A good threshold will be say 10% p.a. All the SIP horizons spend reasonable amount of time below 10% p.a.
Another point to note, longer the SIP, better the odds of making fine returns. We already know that. Don’t we?
Good returns have not always come even in the past. Even if the returns were good, past performance does not guarantee future performance.
Now, to the absolute returns. There is easier to relate to.
You could have put money in a recurring deposit. It would have accumulated 11% (of the amount invested) in 3 years, ~20% in 5 years and ~30% in 7 years. A RD of Rs 1,000 per month for 3 years would have become ~40,000 in 3 years (total investment of Rs 36,000).
Remember it is a recurring deposit and not a fixed deposit. I have assumed a 7% return in RD (there have been times in the past 2 decades when the RD returns have been higher).
SIP on Nifty 50 TRI does well but there are times when even a simple bank deposit would have beaten the Nifty SIP over the long term. Enough to test your patience.
The following chart is quite telling. It shows the percentage of time Nifty 50 TRI SIP would return in a specific range. For instance, for a 5-year SIP, returns have been more than 15% (annualized return), 39.6% of the time. The returns have been less than 5% p.a. 6.3% of the time.
For a 3-year SIP, the return has been negative 11.1% of the time.
What does this tell us?
Investing by way of SIPs does not guarantee good returns. It does not even guarantee positive returns. However, the longer your SIP duration, the better are your odds of getting decent returns. Do note I have used index data. You may be running your SIP in an active fund, which adds an additional variable of fund manager risk.
Running a SIP for long duration does not mean that you stick with the same fund forever. You need to review your scheme performance on a regular basis and chuck out underperformers. And shift the existing investments and the SIP to another fund. If you do not want such headache, you are better off investing (or running SIP) in index funds.
Additionally, there is no cost-less way of investing in Nifty 50 TRI. Even an index fund will have an expense ratio and tracking error which will bring down your returns. Hence, in a way, I have shown you the best-case scenario.
This is not to say that the SIPs are a bad way to invest in equity funds. In my opinion, SIPs remain the best way to invest for most investors. I invest by way of SIPs (not just SIP though).
However, you must get your expectations right. SIP in mutual fund does not guarantee good returns.
The results point out that we need to tone down our expectations. My profession requires me to interact with many investors. Many new investors believe that they cannot go wrong with SIPs and the good returns are guaranteed. This irrational expectation from the equity markets or your MF scheme is the problem. These investors are fine with the short-term drawdowns.
However, when you come with high expectations and realize that after 5 years of SIP instalments, the returns are much lower than a bank fixed deposit, frustration ensues, and the investment discipline can get compromised. It is not difficult to give up when the reality has underperformed the expectations in a big way. And there is no guarantee that the fortunes will change. If you are investing in an active fund, there is another variable, that of fund manager risk. What if everybody else is fine and only your fund sucks?
In my opinion, more than anything else, these results should nudge you to moderate your expectations from SIPs. It will help you stay invested.
For the most of us, the following shall suffice.
- Focus on asset allocation. Get your asset allocation right.
- Moderate your return expectations.
- Keep making periodic investments (SIP or otherwise). Keep it dull and boring.
- You can add some spice at times by attempting lumpsum investments and redemptions based on PE-based valuation or technical analysis, but don’t overdo it. Too much of this will likely be counterproductive for most investors.
- If you are investing in active funds, keep assessing their performance and its source (difficult to do). Give them a long rope but do not get attached emotionally attached to your scheme.
- Rebalance portfolio on a regular basis.
- Make the process as mechanical as possible or your mind will play tricks.
If this is too much for you, seek professional assistance.