How long is long term? Should one take a SIP?

I was talking recently with a couple who are our clients. The couple wanted to invest regularly for their children and were looking for alternatives. Since they were just starting off and the amounts were relatively sdirect equity investment was not very practical and hence I suggested Systematic Investment Plans in Mutual Funds. They were somewhat skeptical. They said that their experience with SIPs had not been too good.

Now there may be some subjectivity here because they (like most people) did not know the exact capital invested and the annualised returns that they had got. They only knew that the returns were “not very good”. It could be a case of wrong interpretation of returns, excessive expectations, bad choice of mutual fund schemes etc.

However it got me thinking. What if someone had invested in a SENSEX index fund on a SIP basis? What would have been the experience? I have taken SENSEX instead of NIFTY as it has a longer period for which to make calculations. I have ignored dividends as they would go towards asset management charges, entry loads etc.

The first chart indicates the terminal value if a SIP has been done for Rs. 10,000 every month starting in various months from 1979 to 1999 and ending 10 years later from 1989 to 2009. This would involve a capital investment of Rs. 1,200,000 (Twelve lacs) or 10,000 multiplied by 120 months.

The terminal values would range from Rs. 120 lacs to Rs. 10 lacs. At Rs. 10 lacs terminal value obviously there would be a loss since Rs. 12 lacs would have been invested.

 

The annualised yields from 10 year SIPs would range from +43% p.a. to -3.6% p.a.. Obviously a very large and unacceptable range for financial planning purposes. A long term investment horizon and a Systematic Investment Plan would not be a fail safe formula in many cases.

 I had a re-run of the investment performance assuming a time horizon of 20 years. The results here were more heartening.

The chart below indicates the terminal value if a SIP has been done for Rs. 10,000 every month starting in various months from 1979 to 1989 and ending 20 years later from 1999 to 2009. This would involve a capital investment of Rs. 2,400,000 (Twenty four lacs) or 10,000 multiplied by 240 months.

The terminal values would range from Rs. 252 lacs to Rs. 77 lacs. Even at Rs. 77 lacs terminal value obviously there is no loss since only Rs. 24 lacs have been invested.

The annualised yields from 20 year SIPs had a much more acceptable range from +20% p.a. to + 10.5% pa. A long term investment horizon of around 20 years and a Systematic Investment Plan would most likely not result in hardship for investors.

So what are the lessons from this exercise?

  1. Long term as is normally understood is an underestimate. The Government classifies an investment more than a year as long term. The investment professionals sing virtues of having a long term investing horizon defined as a 3-5 years horizon. I would propose that an investment horizon of around 20 years would be truly long term!
  2. Long term is in reality not very long. Considering the fact that a person joining employment at the age 25 and retiring at 60 spends 35 years waiting to grow a retirement corpus or the fact that a new born will go to college around 15 and join a business school at 20 or get married between 25 and 30, in our lives the goals that we want to achieve are sufficiently long for equity investments. 
  3. While market timing does not make sense, valuing the market may be very important. If one were to avoid investing at times of bubble and actually reduce equity exposure and increase equity exposure in down markets, the results would be dramatically different.
  4. Avoiding some perennial value destroying sectors would also improve the results dramatically. 

Points number 3 & 4 are subject matter for further calculations and a future post. Happy investing!

12 Comments

  1. Dear Rajeev,

    Thanks for that perspective. It reaffirms the role of commitment in any endeavor one takes up, investing is no different. Underlying laws of nature govern every change, if something has to take time, it will, you cannot hasten ripening.

    I was wondering, which are the, ‘perennial value destroying sectors,’ you hinted, in your write up? Cyclical sectors, as the name suggests, should be logically avoided, when one has long horizon. What else do you feel are best avoided?

    Also in your third point, as I understand, that in every boom bust cycles there a part of the cycle/graph is excessively tilted and valuations get absurd, either ways and can be indicators to revise our debt equity ratio, but this gets relatively more clear on the hind side (retrospectively). So is this shift to revise asset allocation based on reasonable assessment of market valuations which might eventually prove wrong but its worth taking a call?

    With Warm Regards,

    Vishal

  2. Dear Rajeev,

    Thanks for that perspective. It reaffirms the role of commitment in any endeavor one takes up, investing is no different. Underlying laws of nature govern every change, if something has to take time, it will, you cannot hasten ripening.

    I was wondering, which are the, ‘perennial value destroying sectors,’ you hinted, in your write up? Cyclical sectors, as the name suggests, should be logically avoided, when one has long horizon. What else do you feel are best avoided?

    Also in your third point, as I understand, that in every boom bust cycles there a part of the cycle/graph is excessively tilted and valuations get absurd, either ways and can be indicators to revise our debt equity ratio, but this gets relatively more clear on the hind side (retrospectively). So is this attempt to revise asset allocation based on reasonable assessment of market valuations, which might eventually prove wrong, but its worth taking a call?

    With Warm Regards,

    Vishal

  3. Dear Vishal,

    You may find the presentation at the link given below interesting. It shows the returns earned by different pairs of stocks where Buffett kind of stocks (low debt, high ROE, high entry barriers, good management, simple businesses) beat other kinds of stocks very easily.

    http://ppfas.com/pdf-docs/b-finance/where-is-the-proof.pdf

    As for cyclical stocks, Peter Lynch has written some good stuff in his book Beating the Street. These stocks can never be buy and hold but have to be bought and sold, bought and sold. Very difficult to do unless you have a very good insight in the sector.

    As for market valuation, I am planning to do some back testing. Something like a modified Systematic Investment Plan. I have used price earnings ratio in the example below, it could be anything else, price book, dividend yield etc. The exact modalities are yet to be worked out but it would go something like this…….

    The same Rs. 10,000 is invested each month in equities. If however the market is in very overvalued territory (say P/E in excess of 20 on trailing basis) the investment is held in liquid funds. These liquid fund investments would be converted to equities only if the market returned to some fair valuation metric like say a P/E of 15. The aim is just to avoid investing at the time of a bubble.

    Similarly if the market valuation parameter crosses some number, say a P/E ratio of 25, sell everything (including accumulated units under SIP) and stay in cash.

    I will work on the modified SIP as and when I shake off the lethargy and take out time from routine activities, the results would be interesting I guess.

    As active investment managers the lesson for us is, not to seek money at times of frenzy and shut the doors to our office. Going on an extended holiday would be a good idea.

    Regards,

    Rajeev

  4. Hi Rajeev, very well researched article,u people at ppfas are really very hardworking.
    1. I must u will get astonishing returns when u switch to liquid fund in euphoria or high pe time of the mkt but returns can be more fruitful when instead of entering into liquid fund if one enter into debt mutual fund ,coz at the time of pe more than 25 there is very good chance of high interest rates and high bond yield which wili give good return on these period.
    2. I was reading comments frm dr vishal its really good but i want to ask u one thing mr rajeev on cyclical . To my views in these time everyting is getting more and more cyclicle (in my sense cyclical means business cycle),in earlier time pple used to IT sector is non cyclical but now it also depends on the currency and business cycle of other sectors e.g financial,manufacturing ,auto.I sector which was spared Pharma sector now it also related directly to currency derivative coz of exports and fccb.Now the defination must be changed frm cyclical/non cyclical to debt free/debt loaded company ,companies which remains debt free will survive and grow in coming yr business cycle others will be busy in debt restructuring rather than growing .I might be wrong if so then pl correct me.
    Warm regards
    randeep singh

  5. Dear Rajeev,

    Thank you, for answering the queries.

    When other broking houses encourage investors to buy, in lure of extra commission, knowing what might follow, your willingness to close shop, during such period, reflects your integrity.

    With Warm Regards

    Vishal

  6. Dear Randeep,

    IT at a global level has always been cyclical. For example IT spends collapsed after the dot com bust. In India, companies like Infosys, Wipro etc. have seemed immune from cycles because the market share of IT offshoring companies (especially from India) has been steadily increasing. Hence even in a situation where say US companies were cutting IT budgets, Indian companies increased their sales as they gained market share.

    A few things have changed of late. US companies like IBM, Accenture and HP + EDS have started moving work to low cost destinations like India. For example, IBM has as many employees in India as Infosys. Hence the huge cost advantage of Indian companies is a thing of the past. (One of the reasons we like Mphasis is this. Mphasis is a $ 800 million company and a subsidiary of $ 40,000 million company HP + EDS. Mphasis should benefit enormously on account of work offshored by HP + EDS.)

    The other thing is that the larger Indian companies are already operating on a significant scale and gaining incremental market share from here is progressively difficult.

    IT companies were always exposed to foreign exchange fluctuations.

    When we are talking about non cyclicals we are referring to sectors like FMCG, Pharma etc. which are not that vulnerable to business cycles.

    Warm regards,

    Rajeev

  7. thanx Mr Rajeev, for responding to my comment.Today i want to made discolsure to you that i am regularly investing in a sip from last 3 years in fund named DSP BLACROCK EQUITY Fund ( earlier known as DSP MERILLYNCH EQUITY Fund ) which came out with insurance cover along with mtual fund .It was named as SUPER SIP.My earlier aim was to keep on investing for more than 10 years as that time i was investing actively in equity .So the sole aim was to regular invest for more than 10 to get goodreturns in long term. As i had never made switch to liquid fund or debt fund ( this funddoesnot allow switch as insurance over attachedto it ).My whole idea of disclosure to you is to get answer for fewqueries .
    1.Should i stop it so that i an enter into fund that will allow switching to liquid or debt fund OR
    2.should i redeem the money to liquid fundat the time of bubble or markets trading more >27 pe and rest of sip to remain continue.As the sip allows redumption but not switch and continuence of sip will lead to insurance cover.
    As of now i had learnt to manage investment actively.When to enter and exit.
    FOR SUPER SIP I AM PAYING ENTERY LOAD OF 5% PER MONTH TO GET INSURANCE COVER OF 20 TOMES OF THE ANNUAL INVESTMENT (e.g as i am investing 2000 per month in super sip where 100 rsis deducted for insurance cover of 480000) for locking period of 20 years.
    Regards
    Randeep Singh

  8. Dear Rajeevji,

    Thanks for a great article. Proof of the pudding is in the eating, thank for the charts to prove the concept. This would really help one take a longer perspective for investment to meet their goals.
    Could you please clarify on the image titles? I doubt the titles are reversed? Please confirm.

    Thanks
    Rishi

  9. Dear Rishishankar,

    The titles are correct (although they are somewhat confusing, I agree). The way the first chart goes for example is a 10 year SIP starting in 1979 and ending in 1989. Various such 10 year SIPs have been tracked over a 20 year period. (this is where the confusion is). The first SIP is 10 years 79 to 89 some other SIP would be 80 to 90 and so on.

    Hope this clarifies the matter.

    Regards,

    Rajeev

  10. Dear Rajeevji,

    Thanks for the quick response and clarification. Would it be prudent to assume a 10-12% return over a period of 20yrs from the stock market?
    I love your comments on long-term esp point #2. I think one should consider a period of atleast 15yrs as long term investment as against the 5+ yrs floated across by everyone.

    Thanks
    Rishi

  11. A 10% to 12% return would be prudent. However what really matters is post tax, inflation adjusted returns for the investor. A 5%+ inflation adjusted post tax return is what one should aim for. One should try to invest in businesses which have pricing power, rather than those which struggle to pass on cost increases to customers.

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