Many of life’s failures are people who did not realize how close they were to success when they gave up. –Thomas Edison
Key takeaways:
- We are potentially moving into a period of time when investment returns may be lower than the historical average. However, the gap between the return from equity mutual funds and risk-free fixed deposit type of instrument is unlikely to fall much. So, when fixed deposit rates were 8%, equity return was around 14%. Now, when fixed deposit interest rates are ~5%, equity returns may be in the range of 10%-12%. It will be below historical average return but unlikely to be below the return from safe risk-free instruments.
- There could be periods when return from equity SIPs is volatile and potentially lower than the safe option of fixed deposit. Instead of throwing in the towel, one should persist with his/her financial plan. One could reduce risk of large losses by investing in systematic manner. Boost investments when returns are low or market is down. Don’t redeem when market has fallen off the cliff.
- How much you invest, how long you remain invested are very important. If the returns are likely to be lower, one should boost investment amount to achieve financial goals ( Four key elements of effective investing).
Over the last few weeks, we have been hearing about acceleration in outflows from equity mutual funds and fall in SIP investments as well (August mutual fund outflow highest in a decade). This is not desirable but not surprising either. The beauty of SIP is to invest across good and bad times. If one stops SIP or redeems his/her investments during downturns, that is the worst possible mistake an investor could make.
Having said that we are amidst unprecedented crisis. We want safety and security. Human actions are driven by our recent experiences. And the recent experience of investors has not been that good. Naturally, patience of most of the investors is running thin . This is despite the fact that equity markets have recovered substantially from their march 2020 lows. However, this doesn’t mean that the long-term investors are sitting on hefty gains.
The table below shows the return from various categories of the mutual fund scheme. We can see that return over most historical periods are in single digits for most categories of the fund. These returns are below the historical average return from Indian equity market.
Data as of Sep 30 2020
Have the SIPs performed well?
SIPs tend to perform well when there is volatility but market is moving upwards. While we have seen lots of volatility in the market, NIFTY has been broadly in a range. As a result, SIP returns are also in single digits over most time period.
Below is the SIP returns from NIFTY (excluding dividends). Based on data since Jan 1994, 5-year SIPs tracking performance of NIFTY have delivered an average return of around 12%. The latest 5-year SIP return is half of the historical average return.
However, low returns has been across most asset classes, not only from equity mutual funds
If we look across different investment opportunities, returns have fallen across most asset classes. Below is the fixed deposit interest rates from different financial institutions across different tenures. In most cases, the return from fixed deposit is less than 6% (even for fixed deposits of 5 to 10years). If one is in higher tax bracket, post-tax return is likely to be 4% or less. With inflation of 6%, clearly such investments are unlikely to protect purchasing power.
Same is the case with real estate. In most places in India, the real estate prices have largely remained stagnant. Equities have also
What does this mean for future of mutual fund returns?
Return from most asset classes oscillate around long-term average returns. Periods with high returns are followed by periods when returns are low and vice versa. When we look at NIFTY (data since 1996), we observe that after 6 years of stagnation between 1996 to 2002, market delivered good return between 2003 and 2007. This pattern of stagnation and growth has been repeated multiple times.
Since Dec 2017, market has not gone up much. After around 3 years of stagnation, possibility of better returns going forward are higher.
Why we should continue to invest in equity mutual funds?
Here we show why it is important to keep investing in equity mutual funds. If someone had started an annual SIP in 1996 in NIFTY (100 rs invested every year at the start of year) and also started a SIP in fixed deposit (8% annualized interest), most of the time, the value of equity portfolio would have been above the value of fixed deposit. The chart shows evolution of both fixed deposit investments and SIP in NIFTY through different phases of equity market.
Furthermore, if someone had left hope in 2002, he/she would have missed all the wealth accumulation that happened between 2003 to 2007.One can argue that the below might not be replicated or is also dependent on starting point. That to some extent is true and hence, I always recommend to look at the average return of SIPs. Average return from 10-year SIPs since 1996 is (as mentioned in the table above) is 13.7% (excluding dividends). Even if the future return is below this, it is unlikely to be less than other investment options available.
Remember:
- We are potentially moving into an era where investment return may be lower than historical average. However, the gap between the return from equity mutual fund and risk-free fixed deposit type of instrument is unlikely to fall much. So, when fixed deposit rates were 8%, equity return was around 14%. Now, when fixed deposit interest rates are 5%, equity returns may be in the range of 10%-12%. It will be below historical average return but unlikely to be below the return from safe risk-free instruments.
- There could be periods when return from equity SIPs is volatile and potentially below than the safe option of fixed deposit. Instead of throwing in the towel, one should persist with his/her financial plan. One could reduce risk of large losses by investing in systematic manner.
- How much you invest, how long you remain invested are very important. If the returns are likely to be lower, one should boost investment amount to achieve financial goals.
Disclaimer: The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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