Dollar Cost Averaging aka SIP analysis of S&P 500 and BSE Sensex

What we know as Systematic Investment Plan is an investment strategy (not a financial product!) derived from what is known in the US as Dollar Cost Averaging. Obviously the term SIP sells better(than Rupee cost averaging) !

The Indian stock market is a toddler. Sensex data is available from only 1979. Many have argued with me that stock markets should be analyzed only after liberalization- that is from the early 90’s. So that would make the market an infant, arguably a premature one at that!

The reason for saying that is, the conclusions that one usually makes like, “sell when Nifty PE is >23” etc. are all based on this short history that we have and hence unreliable. It is only when we look at market data over tens of decades, can we understand how it works and how little we understand it. Mandelbrot used over150 years of cotton prices to show to the world that the assumption of normal distribution is wrong.

What if we took S&P 500, the US broad market index, for which data is available from 1871 and studied long term SIP returns on rolling basis (explained below)?

That market has seen two world wars, recessions, terrorist attacks, assassinations, scandals to name just a few. How much has the SIP (DCA) returns varied over say, 15 year periods?

The following was done to answer that question.

Monthly S&P price data, along with inflation index, and 10 year Gov bond rates are available from 1871 here

http://data.okfn.org/data/core/s-and-p-500

Unfortunately, Excel will recognize dates only 1st Jan 1900. So we work with that.

Jan 1900 to Jan 1915 represents the first 15 year SIP period for which return (XIRR) is calculated.

Feb 1900 to Feb 1915 is the second period. We have now rolled over the investment duration. 

We roll over until May 2015 is the end date of the last 15-year period.

There are now 1025 such 15-year periods from Jan 1900 to May 2015.

Rolling SIP returns (automated version coming soon) can easily be calculated with a simple Excel macro in about 45 seconds. Then we stare at the graphs in search for wisdom.

Click on the graphs if you wish to see a clearer image.

S-&-P-500-Dollar-cost-averaging

S-&-P-500-Dollar-cost-averaging-2

 

 

The SIP returns are the same in the top and bottom graphs. The top graph has the inflation rate for the corresponding investment period. The bottom graph has the 10-year bond  interest at the end of the SIP period.

Each blue point is a 15 year SIP return. Notice many of then are zero. This means, that there is a loss. Expenses have been neglected!

Notice how strongly the return depends on when you start the SIP!!! 

For several periods, the return is zero or below inflation. Inserted the 10Y interest rate data more for information. Don’t wish to conclude anything with it.

Moral of the story: There is no guarantee that SIP will work for any number of years. Since when you start the SIP matters, active management is essential as the financial goal nears. People who recommend equity for short durations are selling products and/or have little knowledge about investment risk.

Sensex-Dollar-cost-averaging-3

Sensex-Dollar-cost-averaging-4

 

15-year rolling SIP returns

Sensex-Dollar-cost-averaging-5

 

Notice the number of times the return has fallen below 10% (before taxes).

If you want guarantees that your SIP investments will ‘work’ or help you achieve your goals, you are barking up the wrong tree.

Do share if you found this useful


About the Author M Pattabiraman author of freefincal.comM. Pattabiraman is the co-author of two books: You can be rich too with goal based investing and Gamechanger. “Pattu” as he is popularly known, publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis, including a robo advisory template for use by beginners. Contact information: freefincal {at} Gmail {dot} com He conducts free money management sessions for corporates (see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints.

Content Policy

Freefincal has original unbiased, conflict-of-interest-free,  topical reports, reviews, commentary and analysis on all aspects of personal finance like mutual funds, stocks, insurance etc. All guest authors and contributors to the site also do not have any conflict of interest. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. No promotional content We do not accept sponsored posts and link exchange requests from content writers and agencies. This is our privacy policy Our website is non-profit in nature. The revenue from the advertisement will only be used for hosting charges, domain registration charges, specific plugins necessary for traffic growth and analytics services for search engine optimisation.

Create a "from start to finish" financial plan with this unique open-source robo advisory software template


 Don't like ads but want to support the site? Subscribe to the ad-free newsletter! 
You will get the full post-ad-free delivered to your inbox for Rs. 3000 a year. Follow this link to read the terms and sign up! 
Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; where to invest; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. I can do the talk via conferencing software, so there is no cost for your company. If you want me to travel, you need to cover my airfare (I live in Chennai)

Connect with us on social media


Do check out my books


You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingMy first book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.  It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You WantGamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantMy second book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

The ultimate guide to travel by Pranav Surya

Travel-Training-Kit-Cover This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.
Updated: January 2, 2016 — 5:45 pm

40 Comments

Add a Comment
  1. Thanks for this information. Based on SIP returns graph, I would interpret ‘active management’ means: Having the correct asset allocation plan and meticulous rebalancing / profit booking as per asset allocation plan. Otherwise the returns we see in SIP portfolio may get wiped of in next down period.

    1. Yes, but that is not easy to do either. Simple rebalancing strategy is enough imo

  2. Thanks for this information. Based on SIP returns graph, I would interpret ‘active management’ means: Having the correct asset allocation plan and meticulous rebalancing / profit booking as per asset allocation plan. Otherwise the returns we see in SIP portfolio may get wiped of in next down period.

    1. Yes, but that is not easy to do either. Simple rebalancing strategy is enough imo

  3. EXCELLENT WORK….. ASTONISHING TRUTH…………. now can u put graph (for US) inflation verses GOV bonds. it looks like bond is at least never below inflation. let us bite this bullet or bullshit also
    regards

  4. EXCELLENT WORK….. ASTONISHING TRUTH…………. now can u put graph (for US) inflation verses GOV bonds. it looks like bond is at least never below inflation. let us bite this bullet or bullshit also
    regards

  5. Pattu Sir,

    Thanks a lot for the wonderful article.

    A request, can you please share the excel you used to calculate the 5/10/15 year rolling returns. Also, can it be modified and used to get 5/10/15 year rolling return of SIP of a particular mutual fund, or a group of 2 or 3 mutual funds for comparison??

    Regards
    Anil

    1. I will complete the automated version where one can do this and then post it.

  6. Pattu Sir,

    Thanks a lot for the wonderful article.

    A request, can you please share the excel you used to calculate the 5/10/15 year rolling returns. Also, can it be modified and used to get 5/10/15 year rolling return of SIP of a particular mutual fund, or a group of 2 or 3 mutual funds for comparison??

    Regards
    Anil

    1. I will complete the automated version where one can do this and then post it.

  7. Moneylife had written about this about three years back!! moneylife.in/article/sip-smartly/26607.html

    1. And your point is? I don’t claim to publish original research here. I aware of this article and pointed out its limitations earlier.

  8. Moneylife had written about this about three years back!! moneylife.in/article/sip-smartly/26607.html

    1. And your point is? I don’t claim to publish original research here. I aware of this article and pointed out its limitations earlier.

  9. Dear Prof. What is the effect of holding on to say longer period say 20 or 25 years.. especially for retirement? Well the analysis does take one out of comfort zone.. I used to take 12 or 14% for my equity returns.. better to be conservative and cautious..

    1. and also does it take dividends into account?

  10. Dear Prof. What is the effect of holding on to say longer period say 20 or 25 years.. especially for retirement? Well the analysis does take one out of comfort zone.. I used to take 12 or 14% for my equity returns.. better to be conservative and cautious..

    1. and also does it take dividends into account?

      1. I could not find total returns index. Dividends will increase returns by 1-2%. Longer duration will not change results

  11. So what’s the moral of the story? Active mgmt matters, but What’s the guarantee that active mgmt delivers returns?

    Seems to me from the charts that even in well diversified (S&P 500 index) with a SIP, Timing matters. And I think that’s Karma or luck if one needs funds in those years when the Xirr is zero, low or negative. 🙁 may be that’s what pattu means by saying rebalancing closer to financial goals is what’s required.

    1. That there are no guarantees! Review the folio once a year, and protect it as the goal nears.

  12. So what’s the moral of the story? Active mgmt matters, but What’s the guarantee that active mgmt delivers returns?

    Seems to me from the charts that even in well diversified (S&P 500 index) with a SIP, Timing matters. And I think that’s Karma or luck if one needs funds in those years when the Xirr is zero, low or negative. 🙁 may be that’s what pattu means by saying rebalancing closer to financial goals is what’s required.

  13. The article seems to confuse asset allocation and portfolio rebalancing with active management. There are two investment truths that are important

    1. Asset allocation decision: Adding a small amount (say 10%) of bonds (or any other non-risky asset) to a portfolio reduces risk and/or enhances returns.

    2. Portfolio re-balancing can also reduce risk and enhance returns. (especially true when the portfolio deviates from the target allocation)

    That SIP doesn’t guarantee inflation adjusted returns or even a positive return is irrelevant. Firstly, most people don’t have a lump-sum to invest. Most people earn a salary / regular income over several decades, part of which must be invested for retirement (unlike say a film-star whose earnings peak at an early age with little or no income thereafter). Secondly even if a lump-sum is to be invested, it makes sense to spread the investment over a few years (not decades) to avoid the risk of investing at the market peak.

    1. The ‘article’ neither speaks about asset allocation or rebalancing!
      “That SIP doesn’t guarantee inflation adjusted returns or even a positive return is irrelevant.” Maybe for you. I and not a “film star” and I dont have a lump sum to invest.
      Btw neither of those two strategies can guarantee a real return.

  14. Thanks Pattu and a nice one. It would be an interesting analysis for the what-if scenario of – how would this play out while combining the equity and bond (say in 50:50 ratio) and maintaining it all through in each month of the 15 yr period.
    Is the final return over the inflation (always?) and by how much (in percentage terms considering inflation as the base)?

    And that IMO, is all that an individual investor should worry about!

    1. Thanks. Don’t think such a folio will not always beat or even match inflation too. If 50% of your folio returns 0% or negative, your net portfolio return would not be much!

      1. sir,
        but what happens if a US like scenario happens , where equity (some times ) give ZERO or negative and DEBT may be GOVT debt at least gives better than inflation, (as per your analysis). or it can not happen in MY INDIA
        regards

        1. It has occurred in India between 1992 to 2002. So defintely possible.

      2. Hi Pattu, actually, juxtaposing (and to a large degree, negative correlation between the equity and bond trend line) of the two graphs of the S&P500 gave me that impression – of, having a mix of equity and bond would have ‘nearly always’ beaten inflation – but, i might be wholly wrong 🙂 and looking more closely, the y-axis scale difference might have did me in 🙁

        But, using this data set – on the quest of a combination that would have beaten inflation ‘always’ and to elaborate on my first comment of maintaining the ratio (month over month between the equity and bond), is basically re-balancing (which, in practice would complicated for an individual investor (on a monthly basis at-least), but a good starting point to align our thoughts).

        You know where im going with this 🙂

        1. What happens in an active managed folio cannot be backtested. For a simple index equity and index bond fund, the answer to, would it have beat inflation if present is 50:50 ratio, the answer is no. It is impossible if one asset class returns 0% or less than that.

          1. Ah yes, i do see that. For this combinatorial exercise, i meant simple index equity and GOV bond (same as the S&P500 index, bond and the inflation data set used for this post).

            The only thing left is to see is – would not the constant re-balancing for the equity portions (yes index one), not end up at-least give a bond like return? Thus bringing us closer/bettering the inflation line..

  15. Hi Pattu,

    Good Article and it raises a interesting question..It would be interesting to see what are the number of periods for which the XIRR is greater than a certain return(lets say 12%).For example for the 10-year rolling SIP returns ,by looking at the graphs I think we can argue that for most of the 308 10 year periods the return has been more than 12%(although I cannot tell the exact numbers))

    Can you please update(if its not too much work) the post with the numbers for the number of periods for which the returns are more than 12%(or any reasonable number)?

    1. Let us say that we can argue that way. It does not change the central result that your return after a 15Y sip could be quite low – lower than inflation.

      1. Yes.I do accept that your statement is true”Notice how strongly the return depends on when you start the SIP!!! “.But shouldn’t that be balanced by the fact that if we invest in an SIP for over 15 years probability of getting returns less than inflation is very low(as per the number of data points in your graph).It would be interesting and helpful for me if you can update the blog post with the number of periods for which the returns are less than inflation

  16. Hi Pattu,
    Just a thought if you can add index PE, I am thinking if positive xirr corresponds with a certain low PE ?

  17. Pattu Sir
    If the Moral of the story is that – There is no guarantee that SIP will work for any number of years then is there any justification of continuing SIP in MF? Instead at least trying to timing the market as far as possible (not very hard pressed just simply trying) and invest lumpsum manually seems to be the more optimum strategy w.r.t. investing in MF. In that case the famous notion of MDBSC* rocks does not hold any more …. what is your opinion?

    1. Where is the guarantee that timing the market will work?!

Leave a Reply

Your email address will not be published. Required fields are marked *