This tool allows you to compare different mutual fund investment modes like SIP, growth-SIP, lump sum, STP and VIP. Using historical Sensex monthly data (source: Capitalmind.in) it calculates, for each investment mode, the probability of loss (ie. portfolio value less than total investment). It also calculates the probability of one mode outperforming the other. For example probability of growth-SIPs doing better than SIPs, STP doing better than lump sum etc. For an input investment duration (eg. 10 yrs) the probability calculations are made by considering every possible such duration between a start year and an end year which can be chosen between 1980 to 2012 (277 such periods for 10 yrs duration).
Before I discuss some results obtained from the comparator, here are simple definitions of each investment mode:
SIP: Buy mutual fund units each month with a fixed amount.
Growth-SIP: Same as above but the investment amount increases each year (typically by a fixed percentage)
Lump sum: Make a one-time purchase of MF units with a large sum of money.
STP: Systematic transfer plan. Instead of making a lump sum investment, invest smaller (typically equal) chunks of the amount over a few months to decrease market risk associated with lump sum investing.
VIP: Buy more MF units when the market (therefore the fund and therefore the investor’s portfolio) performs lower than expectation and vice versa. So you need to set an expected return, a min, nominal and maximum amount for monthly investment. The expected portfolio value is calculated with the nominal investment amount. You can read more about this here.
Results: I have already reviewed the VIP vs. SIP investment mode and found the former not as impressive as it is made out to be. So let us look at the other modes. Both probabilities mentioned above were calculated for all possible 3,5,7,10,15,20 and 25-year periods between 1980 and 2012. Results are summarized in the graph below.
- If you are investing in mutual funds for less than 10 years then irrespective of the mode of investment there is a non-zero probability that you will lose money (graphs in top row). Shorter the duration higher the probability of loss.
- For a 7-year goal the SIP mode has only 75% chance of reaching the target. It is much less for lower durations (bottom row, left graph)
- For durations of more than 15 years the SIP has little chance of loss and high enough chance of bettering the target. Of course we must remember that history never repeats itself when we want it to.
Lump sum vs. STP
- Interestingly both lump sum and STP modes have similar probability of loss irrespective of duration.
- The chance of STP doing better than lump sum mode is only 25-35% for all durations.
Growth-SIP vs. SIP
There are two kinds of growth-SIPs. Suppose you use a goal calculator and determine Rs. 5000 as the SIP amount needed to achieve a goal. One way to do a growth-SIP is to start with Rs. 5000 and increase the amount each year by, say, 10%. The other way to do a growth-SIP is to determine the initial SIP amount needed to achieve the goal for a pre-determined annual increase in the SIP amount (say 10%). In this case the SIP amount will be smaller. Let us say it is Rs. 3200. Thus we have:
SIP: Rs. 5000 every year
Growth-SIP I: Rs. 5000 increasing each year by 10%
Growth-SIP II: Rs. 3200 increasing each year by 10%
Comparing SIP with growth-SIP I (GSIP-I) and claiming GSIP as superior is silly since you are investing much more than a SIP. Because you invest more the chance of reaching of GSIP-I doing better than a SIP is always 100%! For the same reason GSIP-I also has a higher chance of bettering the (SIPs) target. However, the probability of loss is nearly the same as that of a SIP. Unfortunately many ‘experts’ only make this kind of comparison (see postscript below).
Comparing GSIP-II with a SIP makes much more sense because the total investment amounts are comparable and both amounts are calculated for the same target. What is interesting is the average interest rate (compounded annual growth rate) is identical for both GSIP-I and GSIP-II and always higher than that for a SIP. The probability of loss for I and II is also identical (and nearly same as that for a SIP). However,
- The probability of GSIP-II performing better than a SIP is practically miniscule irrespective of duration. A SIP has a better chance of better the target than a GSIP-II (graphs in the bottom row).
- Of course if you have the money, increasing the SIP amount each year whether your goal calculation recommends it or not makes sense. You are increasing your chances of success. Doing/recommending this is not ratification of GSIP-I. It is ratification that the standard SIP method has a high enough chance of failing.
- Use MFs with caution for medium-term (less than 10 yr) goals. Of course stay away from them for short-term goals.
- Just because you have started a SIP hardly means you will achieve your goal. There is a strong enough chance that you won’t and decent chance you will lose money!
- For the long term investor the STP mode offers no great advantage over the lump sum mode in terms of risk. There is about 25% chance of higher returns with the STP mode. For short durations STP could lower risk, but then again why would you want to invest a large amount in MFs for short durations!
- Unless you have a lump sum to the tune of, say, 500 times your monthly savings, don’t bother with a STP. It is not worth it. At least don’t bother searching for a liquid fund to do the STP. A STP can be done with a SB account! It is ridiculous how many ‘experts’ focus on the higher returns of a liquid fund over a SB account and recommend a STP without considering tax issues. If you are a fan of STP, at least choose a liquid fund with daily/weekly dividend option to minimise short-term capital gains from the source fund.
Perhaps we should do away with all goal calculators and instead practice/advice: invest as much as you can, as often as you can and do remember no investment mode is fool proof.
Postscript: Moneylife Magazine carried an article titled, SIP Smartly (needs a min subscription of Rs. 100 99/- to fully view the article. Money well spent though.) in June 2012. It claims to the ‘first comprehensive and unbiased research on SIPs’. Don’t know about ‘first’, likely to be unbiased - given their reputation, but it is certainly not comprehensive. It does not take into account durations higher than 10 years. As seen above it is very important to do so. They also consider only GSIP-I.
(.xlsm files made in Excel 2010. Should work in Excel 2007. Macros need to be enabled in order for the excel file to run. If you need a .xls version leave a note in the comments section)
Version 1: Here the SIP amount is an input and the target amount is calculated for given rate of return.
Version 2: Here the target amount is an input and the SIP amount is calculated for given rate of return.
Version 2 is based on suggestions from Sreekant Vaithiyanathon (comments section), founder and financial planner at MoneyCare Solutions
Needless to say, feedback will be greatly appreciated.