Last Updated on April 5, 2016 at 5:35 pm
While recommending equity as an asset class or equity mutual funds as an instrument suitable for newbies, illustrations about the power of compounding, past returns and how they have comfortably beat inflation are typically used.
This is followed by caveats (besides past performance disclaimers) that the investor must
- be ready to stomach the ups and downs of the market,
- ride the course,
- stay invested no matter what,
- get used to volatility etc.
These caveats are typically not quantified. Even if done (as attempted here in the past), they do not help in preparing in the investor for the journey ahead as much as they should.
In the post, which I would like treat as the second part of Asset allocation for long-term goals, let us discuss about ‘what to expect’ when you invest in equity mutual funds.
🔥Secure your future with our Robo-advisory tool trusted by over 3,500 investors and advisors. From effortless retirement planning to funding your children’s biggest dreams, turn your financial goals into reality. 🔥
Subscribe for money management solutions via email! (Link takes you to our email sign-up form) Join 32,000+ readers in our community.
👉 New Tool Alert! NaviPlan: A Privacy-Focused Multi-asset Tracker and Goal Planner 👈
There are two aspects to investing in volatile securities:
1) ‘How’ to expect: For the investment period I have in mind, how much could returns vary? How can I quantify this?
This is of course based on backtesting. While the future is unknown, quantifying past volatility tells me that I should expect at least that much fluctuations in return in the future.
This was earlier covered for debt mutual funds:
Debt Mutual Fund Returns: How to expect when you are expecting!
and equity mutual funds in two parts*:
How much can I expect from equity as an asset class for long-term goals? Part 1
How much can I expect from equity as an asset class for long-term goals? Part 2
(*) link titles are different from post titles to avoid confusion.
2) ‘What’ to expect:
‘How to expect’ helps me conclude that for the investment period I have in mind, the return could be anything between: (R-X) to (R+X).
Where X is a suitable volatility measure (typically standard deviation).
However, it does not give me an idea of how much my portfolio will drop in value for a particular asset class or for a particular asset allocation.
Let us try and address this now.
We shall consider the same portfolio used in Asset allocation for long-term goals
Franklin Indian Blue Chip as representative of equity and Franklin Indian Income fund as representative as debt. These are among the oldest equity and debt funds in the market.
This is how the NAV movement for each fund looks like
The data is from 5th March 1997 to 5th May 2014.
We will now calculate a metric known as maximum drawdown.
This simply refers to the maximum percentage fall from a peak for a given time period.
For the above mentioned period, a portfolio that has 100% equity would have experienced a maximum drawdown of 74.6%
How many young investors who claim to have ‘high risk appetite’ could have endured such a fall? Talk, like backtesting, is easy!
A 100% debt portfolio would have experienced a max. drawdown of only about 6%.
Now the max. drawdown for different asset allocations.
The black line is for reference. It is a y=x line.
Investors with 60% to 90% equity allocation suffered a max drawdown of 60-70%. I think it is not a bad idea at all to expect such a huge drawdown to occur at least once during the investment duration.
For 30% to 60% equity allocation, investors suffered a max drawdown a little more than their actual allocation.
That is, an investor with 40% equity allocation suffered a max drawdown of little more than 40%.
Portfolios with 10-30% equity allocation had surprisingly large max. drawdowns.
What is the point of this post?
1) If you have decent amounts of equity exposure for your long term goals (which you must), pay attention to this bit advice from the legendary Bette Davis (24 seconds video)
2) To be forewarned is to be forearmed. In this case, we go one step further and embrace the volatility and welcome a market crash. SIP investors will be able to buy more units automatically. Those who have been stashing cash can mobilize it.
A huge drawdown is a necessary evil.
No other asset class, not gold, not real estate, not fixed income, offers you such wonderful opportunities to profit from, every few years.
Here’s hoping we make the most of it.
We are on Google News
Use this button to add freefincal.com as a preferred personal finance source on Google News.
Add freefincal as a preferred news source
You can also follow freefincal on Google News.
Explore 1,000+ videos on YouTube!
Subscribe to get posts via email!
Join 32,000+ readers and get free money management solutions delivered to your inbox! (Link takes you to our email sign-up form)
Join our WhatsApp Channel
Explore our products
🔥Join our community of 9000+ users! 🔥
Use our Robo-advisory Tool to create a complete financial plan! More than 3,500 investors and advisors use this! Use the discount code robo25 for 20% off. Plan your retirement (early, normal, before, and after), plus non-recurring financial goals (such as child education) and recurring financial goals (such as holidays and appliance purchases). The tool helps anyone aged 18 to 80 plan for retirement, plus six non-recurring and four recurring financial goals, with a detailed cash flow summary.
Our Flagship Course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,500 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market conditions! Watch the first lecture for free! One-time payment! No recurring fees! Lifelong access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Join the freefincal investor circle! An exclusive space for investors, advisors, fintech employees and students to access financial planning and insurance tools, mutual fund and stock analysis tools, coding strategies and Excel macros for data extraction. 750+ members are now part of our investor circle.
Increase your income by getting people to pay for your skills! More than 900 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner seeking more clients through online visibility, or a salaried individual looking for side or passive income, we will show you how to do it by showcasing your skills and building a community that trusts and pays you. (Watch the 1st lecture for free). One-time payment! No recurring fees! Lifelong access to videos!
Track your mutual funds and stock investments with our Google Sheet!
We also publish monthly screeners for
- Equity mutual funds
- Debt and hybrid mutual funds
- Index funds
- ETFs
- Momentum and low-volatility stock screeners
Our Podcast: Let's Get Rich With Pattu
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth!
Audible Link: Listen to the Let's Get Rich with Pattu Podcast
You can also watch podcast episodes on the OfSpin Media Friends YouTube Channel
Listen to the Let's Get Rich With Pattu podcast on YouTube.
Now watch Let's Get Rich With Pattu தமிழில் (in Tamil)!
About The Author
Dr M Pattabiraman giving a lecture
Dr M. Pattabiraman (PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over 14 years of experience publishing news analysis, research and financial product development. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free, AUM-independent investment advice.
Connect with him via Twitter(X) LinkedIn YouTube
Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (Published by CNBC TV18) for DIY investors.
This book helps you ask the right questions and find the right answers. It also includes nine online calculators to create custom solutions.
(2) Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want.
This book helps young earners get the basics right from the start! It will also help you travel to exotic places at a low cost!
(3) Chinchu Gets a Superpower! for kids.
Both the boy and girl versions of "Chinchu Gets a Superpower".
Most investor problems stem from a lack of poor decision-making. We made bad decisions and money mistakes when we started earning, and we spent years undoing them. Why should our children go through the same pain?
What is this book about? As parents, what if we had to groom one ability in our children that matters not only for money management and investing but for every aspect of life? My answer: Sound decision-making. So, in this book, we meet Chinchu, who is about to turn 10. The story follows what he wants for his birthday and how his parents plan it, while also teaching him key ideas about decision-making and money management.
What readers say!
Feedback from a young reader after reading Chinchu Gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from a young age. The importance of money management and decision-making based on their wants and needs. Very nicely written in simple terms. - Arun.
About freefincal & its content policy
Freefincal is a News Media organisation dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News.
Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication.
Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact Information: To get in touch, please use our contact form. (Sponsored posts or paid collaborations will not be entertained.)
Our publications
Your Ultimate Guide to Travel
This is an in-depth exploration of vacation planning, including how to find affordable flights, budget accommodations, and practical travel tips. It also examines the benefits of travelling slowly, both financially and psychologically, with links to relevant web pages and guidance at every step. Get the PDF for Rs 300 (instant download)
How to profit from content writing: Our ebook is for those interested in getting a side income via content writing. It is available at a 50% discount for Rs. 500 only!