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The real value of SIPs lies in its tendency to encourage investors to continue investing through thick and thin and thereby, generate better returns from equity

By Dhirendra Kumar | Feb 15, 2018

There are now some six-seven types of SIP available from Indian mutual funds. You can have ‘value-based’ SIPs; SIPs with different periodicities, which claim better returns; SIPs that split monthly instalments into weekly ones; SIPs which claim different dates give better returns; and SIPs that vary your monthly investments according to even more complex formulae.

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That’s a lot of choice, and consumer choice is always supposed to be good, right? Well, not quite. I’ll put it bluntly. Having lots of choices in SIPs is an unequivocally bad thing. These choices misguide people as to what the real purpose of SIPs is and how they can succeed at SIP investing.

Worse, they promote the idea that the way to get better returns lies in some newly discovered trick or feature that is available in some SIPs and not in others. This is a bogus idea. The value of an SIP lies in its simplicity. SIPs are not a magic arrow that will always, without fail, give you better returns than slingshot investing. However, given a general upward trend in stocks, an SIP is very likely to generate better returns than trying to time the market.

Why are investors so concerned about SIPs so as to continually try to improve them with these tricks? At one level, it’s good to see that savers are taking their investments seriously and are minutely examining what they are doing and what effect it is producing. However, the bigger problem is the idea that there is some magic to the very simple concept of investing in a volatile asset by averaging your cost.

An SIP is all about investing a fixed sum regularly in an equity fund, regardless of market conditions. Over the long term, you end up buying more units when the markets are down and fewer when the markets are up. Thus, your average purchase price is much likelier to be lower than what it would have been otherwise. Therefore, when the time comes to redeem your investments, they are very likely to be worth more than what they would have been. That’s all there is. There are no guarantees, and there are certainly no fixed formulae of expected returns. Hypothetically, if the stock market were to go into a general long-term stagnation or decline, then SIPs would lose money. They would also earn you less than a lump-sum investment. But in the real world, since you are investing in something that has high volatility but a general trend upwards, you actually come out well in most cases.

However, there is a bigger reason to invest through an SIP. The real value of an SIP is not in maths but in psychology. SIPs are the simplest way of investing regularly and getting good returns from equity, without having to worry about when to invest and when not to invest and thus often missing out on the best opportunities. When the markets turn discouraging, the general instinct of many investors is to stop investing, either because they are scared or because they are trying to catch the bottom. However, SIP investors – not all but most – tend to continue their SIPs. Soon, when the markets go up, this teaches them the value of not stopping their SIPs in bad markets. Thus begins a virtuous cycle, creating a larger new generation of investors who understand the value of regular investing.

This old article may have references to outdated tax rules and laws. For up-to-date information on taxation of mutual funds, refer to https://www.valueresearchonline.com/tax/

Last week, I received a question from a Value Research Online member which was about real estate as an investment. The questioner has two apartments on which he is paying a certain EMI. These are intended as investments although at some point in the future, his offspring will inherit it. He’d like to know whether it makes sense to sell one of them and make the other debt-free with the proceeds.

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This kind of a query is not uncommon. While the details of a particular question may be different from another, there’s the same dilemma at the bottom: is real estate a good investment? In the go-go years of the real estate boom, no one asked this question because they assumed that real estate was a great investment. However, the boom faded long ago and then the fade became a never ending slump while people kept paying EMIs at higher and higher interest rates. Now, there’s hardly any erstwhile investor whose heart is not full of doubts. Those who bought property from unaccounted cash are quietly holding on but the honest EMI payers are in deep depression.

The answer to this question lies in evaluating real estate investments in the normal terms of any investment–liquidity, safety, transparency, returns and similar parameters. Most people get confused about this because there is a fundamental difference between your first house where you live in and property bought purely as an investment. The first house is a need and when you take into account the fact you can stop paying rent and get a tax break on the EMIs thus getting a big financial advantage. In any case, a first house may or may not turn out to be an investment–it doesn’t matter.

But after that, the case for real estate is shaky. The ticket size is huge, and liquidity is poor. The entire investment has to bought and sold at one go. You may or may not be able to sell when you want to–in a slump, entire markets disappear for long periods. Pricing may be hard to discover. Information is anecdotal and hard to verify. Looking at it sensibly, the answer is clear.

India’s retirees are standing before a difficult choice. They can switch to equity funds, or they can head for old-age poverty. Am I being too dramatic when I say this? Perhaps. I know that some people do not like phrases like ‘old-age poverty’ because it’s a prospect that is too frightening to contemplate. However, that’s part of the reason I use it; it’s something that Indian retirees need to think about urgently, even if they have to be shocked into doing so.

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I’ve said this earlier too but the situation is now getting worse because of dropping interest rates. Because the NDA government is managing its fiscal deficit well, it is more than likely that the returns from deposits will keep heading downwards. The economy may be better off, but that is not much comfort for the retiree who is past his or her earning life. If you are dependent on a deposit for income, then you are heading for large cuts in your income. A cut from 8.5 per cent to 7.5 per cent in a deposit rate means that you lose almost 12 per cent of your income. If interest rates keep dropping, it could get much uglier.

Clearly, the general advice about sticking to fixed-income deposits of various kinds because they are the only safe option for retirees, since equity is too risky, is wrong. It’s not just wrong, but it’s utterly misguided and any senior citizen following it will head for financial disaster.

Unless you have an inherently inflation-adjusted source of income like rent, at some point you are going to face this problem. Interest on deposits will not keep up with inflation and the money you’ll withdraw for your expenses will relentlessly eat into the real value of your savings.

So what’s the solution? Clearly, retirees must invest in equity mutual funds. Looking backwards, let’s take a real example of equity investments. Suppose you had retired in early 1980 with a kitty of R5 lakh that you had invested in a hypothetical investment that tracked the Sensex. Let’s say that your monthly expenses were R3,000 a month and grew at 10 per cent a year.

After 32 years, your monthly expenses would be R63,000. Not only would you have no trouble funding these expenses, your principal would have grown to R2.7 crore! What about the risk? During these years, the investment would have faced up to steep declines in 1987, 1992, 2001 and 2008 and taken them in its stride comfortably. The lesson is clear: if retirees want to spend their twilight years prosperously, then equity is their only hope.

However, I understand that the real barrier is psychological. The fact that equity is risky and fixed income is safe is deeply embedded in our minds, especially in the generation that is now retired or is retiring. So what can be done about this? My firmly held belief is that this problem is not financial, and there are no financial solutions. It’s a problem of mindset and must be cured by changing mindsets.

Over short periods of time, equity is volatile. At the same time, over long periods of time, it is not risky. On the other hand, if you take the real value into account (after considering rising prices), then deposits are not just risky, they are certain to be disastrous.

This is not easy to accept, but it’s the only way.

If there is one myth that fund distributors love to propagate, it is that a fund with a low net asset value (NAV) is cheaper. ‘The NAV is just Rs10,’ is their sales pitch. As a result, investors flock to new fund offerings (NFOs) to exploit this so-called cost advantage.

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In actuality, the NAV is totally irrelevant and should not even be considered when making an investment. Not convinced? Let’s say that two funds have identical portfolios. One has been around for a while and the other is a newly-launched fund. As the value of their (identical) holdings increase, the NAV will rise by the same percentage. So investors in both will benefit equally.

To put it numerically, let’s say the NAV of the two funds are R10 and Rs50 and they rise to R11 and Rs55, respectively. So it might appear that one has just risen by a rupee while the other by Rs5, but in reality, they have both shown a 10 per cent rise.

Of course, the number of units held would differ. A low NAV would imply a higher number of units and a high NAV would indicate a lower number of units. So let’s say you invest Rs5,000. It would get you 500 units with an NAV of R10 but only 100 units if the NAV is Rs50 (assuming no entry load). Yet, in both cases, the value of the investment is identical. So Rs5,000 invested in each would show the same gain. The 500 units (for which you paid Rs10/unit) would rise to Rs5,500 at Rs11 per unit. The 100 units (for which you paid Rs50/unit) would rise to Rs5,500 at Rs55 per unit.

The ‘cost’ of a scheme in terms of its NAV has nothing to do with returns. What you want to buy in a scheme is its performance, not its NAV.

The only instance where a higher NAV may adversely affect you is where a dividend has to be received. This happens because a scheme with a higher NAV will result in a fewer number of units and as dividends are paid out on face value, higher NAV will result in lower absolute dividends due to the smaller number of units. But even here, total returns will remain the same. So from whichever angle you see it, the NAV makes no difference to returns. Mutual fund schemes have to be judged on their performance. And the simplest way to do this is to compare returns over similar periods.

The confusion over NAV arises simply because investors view a fund’s NAV like a stock price. Nothing could be farther from the truth. The current price of a stock could be much lower or higher than its actual value. But the NAV just reflects the current value of the portfolio as it is.

Next time you are evaluating a fund, take a good look at the portfolio and returns over various time periods. Remember, it is the stocks that the fund manager has invested in that determine the returns. The value of the NAV is immaterial.

This old article may have references to outdated tax rules and laws. For up-to-date information on taxation of mutual funds, refer to https://www.valueresearchonline.com/tax/

Face it! Saving often turns out to be a residual activity. One that takes place after you are done with your spending.

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Well, how about a new approach this time? Be as proactive in your saving as in your spending. No, we are not talking about the recurring bank fixed deposit or the mundane savings account.

Instead, we recommend investments made directly in mutual funds on a monthly or quarterly basis. Those funds that you are always meaning to invest in and never get around to doing. And when you do get around to making that investment, you hear of the markets being overvalued and are advised to wait for the inevitable correction.

This is where systematic investment plan (SIP) offers succor. SIP is a way to invest in funds and all funds offer this facility now. Through the SIP option you can invest at regular intervals – like monthly or quarterly. You can opt for the ECS mandate or issue post-dated cheques for investing through SIPs.

Often misunderstood as a strategy for the novice investor, it has more benefits than you can imagine. Apart from eliminating the problem of market timing, discipline and lack of time, they offer a means of compounding your earnings. By investing a fixed amount at predetermined intervals, the headache of figuring out the best time to invest is eliminated and this then offers an efficient way of riding the market volatility. It is also an effective way to avoid making that last minute dash to invest in your tax-saving funds at year end.

As regards the rationale of an SIP vis-a-vis a lump sum investment, valid arguments exist on the benefits of each. However, the argument is based on many ifs and buts of the prevalent market condition as are all investment decisions. Let us make it clear, if you are convinced that the markets can move only upwards and there is no chance of a downside from here, then you will do better by making a lump sum investment. But given the current volatile scenario, even a veteran investor will do well by incorporating an SIP in his portfolio.

With as little as Rs 500 required to run an SIP, you would do well to get your teenage child started on it. Let them witness the virtues of saving and investing from their own pocket money. It’s a lesson they probably will never forget.

The greatest problem that your investments have to solve over the long-term is inflation. We have the lethal combination of inflation and interest rates. This means that the inflation-adjusted interest rates that we earn from fixed-income investments like deposits etc are actually negative when compared to the real inflation rate that consumers face.

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What is worse is that at this juncture, the economic management of our country is such that neither of these problems is going to get solved in a hurry. It could be well be years before fixed-income returns rise above the inflation rate in any meaningful way. For investors who need to preserve and grow their money, this presents a great dilemma.

Equity is one of the assets that has the potential to beat inflation to earn real returns. It is for this reason that your portfolio should have a significant exposure to investments in equity.

However, there’s a problem with that. For the normal Indian investor, investments in equity is psychologically the equivalent of risk. The risk of losing their money when investing in equity, keeps most Indians away from investing in these instruments, even among those who realise the inherent need for inflation beating returns. We have been brought up to mentally equate investing in equity with the volatility of the stock markets. Even people who are peripherally aware of investing are aware that stock markets keep rising and falling sharply. One moment, investors are deliriously happy, and the money is rolling in and in the next they are ruined and devastated.

However, this volatility is just an illusion. In reality, the returns from equity are not only high but they are quite safe too. How can this be? How can returns from a type of investment that is volatile be high and safe. The answer is to understand that the same thing can look very different at different scales.

Here’s a question that will demonstrate the point: How long is the coastline of India? The official answer is 7,517 km. Do you think a person walking exactly along the coast line from Gujarat to West Bengal would come up with this answer? What about an ant? If an ant walked the entire distance, would it come up with the same answer? How about an aeroplane? If you flew an aeroplane along the coastline, would you arrive upon the same answer? No.

In each of these cases the answer would be very different. The ant may come up with an answer thousand of km higher because it would follow each nook and corner of the coast at the scale of millimeters. A human being would follow it on a scale of feet and come up with a lower answer. An aeroplane would follow it only on the scale of many kilometres and would come up with a far lower answer.

Stock market volatility is a bit like this. If you track the markets everyday, you will get many ups and downs. If you track it once a month, there will be fewer ups and downs. On the scale of an year, the ups and downs would be even fewer and if you were to pay attention to the markets only once every two or three years, there would hardly be any volatility. Now, imagine the scenario once in a decade or for even longer periods.

See the two charts below. One is that of the BSE Sensex’ daily movements from 1990 to 2015. The other is the same time period, but marked only once in five years!

The first graph can put the most brave of investors in a difficult and worrisome situation. However, in the second graph, there’s practically no volatility.

If you had invested in equity in 1990 and then bothered to check your investments only once in five years, then sometimes your investments would rise more and sometimes they would rise less but there would be nothing that would justifiably count as volatility. Over longer time such as a decade or more, the movement of Sensex evens out, thereby reducing volatility in reality.

The moral of the story is quite clear: the idea that investing in stocks can lead to frequent losses only if you are a short-term trader. Over sufficiently long periods of time, you are like the aeroplane flying over the coastline. The little twists and turns that vex the ant are not your concern.

But how are you to invest in equity? To invest in equity sensibly and make money out of it, there’s no need to actually get into stocks and shares yourself–equity mutual funds will do the job for you.

This old article may have references to outdated tax rules and laws. For up-to-date information on taxation of mutual funds, refer to https://www.valueresearchonline.com/tax/

Is it a good idea to put R50,000 a year in the National Pension System (NPS) and save some additional tax? It’s a simple question, one that is asked often in all kind of forums. The answer is usually given purely in terms of tax saving. Since the tax saving allowance for NPS investment cannot be used in any other way, the default answer is often that yes, one should invest in NPS because it affords a tax saving that is not otherwise available. And who doesn’t want to save tax.

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Alternatively, you might be told of one of the NPS’ many problems as reason enough to avoid it. The long lock-in period, the compulsory annuity, the taxation at withdrawal etc. Coupled with the fact that (practically) no one is actually trying to sell the NPS with any degree of enthusiasm, it means that a lot of people do not make this tax saving investment in the NPS. And since tax saving is often the only driver for such investments, they never get done.

That’s often the unfortunate fate of investments that are made with only tax-saving in mind. If they don’t get done, then the money doesn’t get invested. What we need to do is to start from another place–from the fact that you have R50,000 that you can spare for savings. Now, what’s the best way to invest these. I made a simple comparison for a colleague of mine who asked me this question. He’s 34 years old so will presumably invest for another 26 years till retirement.

Simplified Case A. He puts R50,000 a year in NPS. He gets a likely 11.5 per cent return and at the end of 26 years has R77.8 lakh. These returns are the 50:50 average of debt returns of 8 per cent and equity returns of 15 per cent, which . He then pays tax on some part, buys an annuity with the rest etc. Simplified Case B. He pays R15,000 tax and invests R35,000 in an equity mutual fund. He gets a likely 15 per cent return (as with the equity part of NPS) and at the end has R99.2 lakh. Tax free, and unencumbered–free to use as it pleases him.

When investors want to know which fund to invest in, they tend to ask the obvious question, ‘Which fund should I invest in?’ As an answer, they are looking for the name of the one fund that is ‘the best one’, according to some nebulous definition of best that they have in their minds. But actually, it’s the wrong question, or at least, that’s the wrong question to start with. If you start with that question and expect an answer in those terms then there’s practically no chance of getting the right answer.

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Actually, the right question is ‘What type of fund should I invest in’? Choosing the right fund is not a bottom-up activity but a top-down one. The reason becomes self-evident when you pause for a moment and think about the original question, ‘What fund should I invest in’? The most important word in that sentence is not ‘fund’ but ‘I’. There are many, many funds that are good enough to invest in. The point is who is investing?

Depending on your circumstances, your financial goals, the time-horizon of your investments, different types of funds will be suitable. Only after the type of fund is defined does the question of which specific fund come up. There’s an old joke that if there is a race between five horses and five humans, then there’s very little point in trying to figure out which human is the fastest. The choice of fund category is a little bit like that.

For example, suppose you have just sold some real estate and have a large sum of money that you don’t need for about a year. Having decided to park the money in a mutual fund for the period you ask someone which is the best fund around without defining your actual need. You are suggested a good mid-cap equity fund which has a five-star rating from Value Research, into which you promptly invest the entire sum. A year down the line, the stock markets remain shaky and your treasure shrinks by perhaps 10 or 20 per cent. Did you choose a bad fund? No, the fund you chose was fine. It’s just that the type of fund chosen was utterly unsuitable for the purpose. For a predictable time horizon of one year, an ultra short-term debt fund would have provided a reasonable return with negligible risk.

Conversely, suppose you are putting aside a certain sum of money from your monthly income for long-term savings, which you may not need at least for a decade or more. In such a case, choosing anything but an equity fund is pointless. The period is long enough for the volatility of the equity markets to be damped out. Since you will be investing gradually in a monthly SIP, you will be able to earn returns that are actually better than the overall gains of the equity markets. However, for such a purpose, a fixed income fund would be most unsuitable. In a high inflation environment like India, fixed income rarely beats inflation and your money effectively becomes less over the years. Any equity fund, even a bad one, would be better than keeping the money in a fixed-income fund or a bank deposit.