Do not expect returns from mutual fund SIPs! Do this instead!

Published: February 24, 2019 at 8:56 am

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Here is why it makes little sense to expect any return from a mutual fund SIP. Instead of focussing on a target return, investors should focus on a target corpus with a clear goal in mind because this is simpler and easier to achieve. In what follows my goal is to discuss the risk associated with equity or any mutual fund investment and not to discourage people from investing in equity.

In this article, huge difference in SIP returns from the same fund: how is it possible, we looked at the five-year rolling SIP returns of DSP Small Cap Fund, investors immediately assumed when the duration is increased, the spread in returns will come down and “all will be well”. Sadly, this is not the case.

Do not expect returns from mutual fund SIPs! Do this instead!

While we have a reasonable number of ten years return periods (in which the spread is significant), any longer then the history is too short to infer anything. So as done previously Dollar Cost Averaging aka SIP analysis of S&P 500 and BSE Sensex, we will have to look at S& P 500 returns data.

Five Year Rolling Returns of Franklin India Blue Chip Fund

To understand why one should not expect any returns from a mutual fund SIP, let us look at rolling SIP returns of one of India’s oldest mutual fund: Franklin India Blue Chip. In a rolling SIP returns graph, each data point is a SIP return for a specified duration and the SIPs are started one month apart.

5 year SIP rolling returns of Franklin India Blue Chip Fund

The number of 5-year data points is 242 (not too much, but reasonable). Now there are two things one can infer from such a rolling returns graph. The spread in returns in the vertical axis. All the way from negative to 50%+. If someone were to start a SIP in this fund or any fund and ask, “what return can I expect in five years?”. Anyone with a pinch of brain and an ounce of conscience would either say: “cannot say” or at least point out that the focus of investing should be elsewhere.

The second aspect is the duration in the horizontal axis. It represents the period in which investments of all 242 SIPs were started: Dec 199×3 to ~ 2014.

Ten Year Rolling Returns of Franklin India Blue Chip Fund

Does the spread get smaller over ten years? Yes, but hardly small enough to expect anything. The number of data points also get smaller (182). Also notice the duration has considerably decreased.

10 year SIP rolling returns of Franklin India Blue Chip Fund

The other worrying aspect is the general southbound movement of the full envelope. One cannot even expect 10% return from a 10Y SIP in future and this is before tax! Someone on YouTube (see video below) commented that this is due to a fall in inflation so real returns are intact. Fact is that actual inflation in India has nothing to with the inflation government reports.

Those government numbers do not account for the price of services like education, medicine, hospitality etc and therefore real inflation is well above reported inflation. So real returns for at least Franklin Blue Chip investors have decreased over the years.

Fifteen Year Rolling Returns of Franklin India Blue Chip Fund

15 year SIP rolling returns of Franklin India Blue Chip Fund

The number of data points further reduce to 11 and the period of investment reduces to about a decade between 1993 and 2003. Since this was a turbulent period with an almost flat Sensex, it make little sense to infer future returns from this investment window. Even then there is a gradual dip in returns here too.

Twenty Year Rolling Returns of Franklin India Blue Chip Fund

20 year SIP rolling returns of Franklin India Blue Chip Fund

There are only 62 20-year data points of investments made between Dec 1993 and early 1999. That is a five-year window. It is silly to judge future returns or expect anything from this graph. Investors when they look at such graphs say they are “de-motivated”.  Sadly, they are missing the point: The message is not to avoid equity. The message is to avoid expectation.

The problem is that many investor have no system of investment in place. They treat mutual funds like insurance policies where all they have to do is to pay the premiums and incorrectly assume despite daily ups and downs, everything will turn out all right. Before we consider the solution to investing without return expectations, let us consider S& P 500 data.

Fifteen Year Rolling Returns of S& P 500 (price index)

The advantage with S&P 500 is the history. We have 1025 15-year SIP return data points. The US was not exactly a developed country in the early 20th century. They went though economic depression and war. It should clear that the spread in a buy and hold 15Y SIP in S&P 500 is simply way too much to assume it would always beat US inflation.

15 year SIP rolling returns of S&P 500 price index

Twenty Year Rolling Returns of S& P 500 (Price Index)

20 year SIP rolling returns of S&P 500 price index

The situation over 20-years (1145 data points) is hardly any different. This is the reason why US finance gurus emphasize on international diversification (which will reduce risk and not enhance always returns).

What is the solution?

So one cannot expect any return, so what is the solution. First let us clarify that a bit. One should not expect any return is the idea is to simply buy units and live in hope. As shown before – How to reduce risk in an investment portfolio, no matter what the sequence of returns is (which is the reason for the return variations), one can with a clear asset allocation plan and step wise reduction in equity can help us reach a target corpus.

So the solution is to replace target return (= expectation) with a target corpus. This is possible only when we are clear about the purpose of the investment. You can download the Freefincal Robo Advisory Software Template and create a concise  plan for each goal. This does assume a 10% return from equity for 10+ year goals, but that becomes irrelevant as the equity allocation is reduced well before the goal dead line.

An alternative to this is to play it by the ear and gradually increase the fixed income corpus and ensure there is enough money to meet the goal, so returns do not matter. See: My personal financial audit 2018

Another alternative is to employ one of the market timing methods discussed and reduce risk. This works only if the investor is unafraid of taxes and exit loads.

Whatever method you choose, there is no need to act as if there is no point in equity investing. It is only a matter of having a goal and a system (only then it becomes a SIP) to reduce risk.

Video Version Part 2 (this post)

Video version part 1

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About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
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