I just started investing in mutual funds how much loss should I expect

Published on / By M. Pattabiraman Twitter: @pattufreefincal

Published: May 22, 2021 at 11:13 am

Balaji asks, “Dear Pattu Sir, You have given proof over and over again that one should not expect any particular return from investing in mutual funds and that there are no guarantees, I have just started my mutual fund investment journey. May I know how much risk or loss I should expect? This will help me prepare for what I am up against.”

The typical question is “what return would I get?” Balaji question, though lacking in detail is most refreshing. We shall discuss loss from equity investing with some example asset allocations. Before we begin, the articles Balaji refers to are these: Do not expect returns from mutual fund SIPs! Do this instead! And What return can I expect from a Nifty 50 SIP over the next 10 years?

We shall use the same dataset and study used to understand the benefits of portfolio rebalancing. We shall consider a systematic monthly investment over 15 years into an asset allocation of 50% and the rest in debt. The NSE 500 TRI will represent “equity”. For debt, we shall consider two cases: the I-BEX gilt index and a simple fixed-income instrument with an annual return of 6% (let us call this FD). The portfolio will be rebalanced once every 12 months. We will consider 137 15-year periods from Jan 1995 to May 2021.

50% Equity and 50% Debt

To appreciate loss, we need an asset allocation. All metrics such as returns and risks should always be first considered at the portfolio level. The maximum fall from a peak for this asset allocation is 34% for equity + FD  portfolio. That is, out of the 137 15-year periods tested, the maximum loss was 34%.

That is the overall portfolio fell by 34%. If the portfolio was 100% equity then the max fall would be about 60%. A detailed study on different asset allocations will be published later. Please note: If an unredeemed loss is notional as some equity mutual fund salesmen claim, then unredeemed gains are also notional!

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    The median portfolio loss was 28%. The 137 data point set can be divided into two sets – the up half with a loss of more than 28% and the lower half with a loss of less than 28%. This is with rebalancing.

    Thus if I hold an equity + FD portfolio with 50: 50 allocation and rebalance it annually, it would be better for me to expect a maximum loss of about 35% and typically losses would be 8-10% below this. Any loss lower than this, then I should consider myself lucky.

    Loss in equity investing has two components: Decrease in value as discussed above and time lost. How long did the portfolio stay below a previous peak?

    For the 50:50 equity + FD portfolio the max no of continuous months ‘underwater’ was 27 months! The medium no of months the portfolio was underwater: 18 months. This means we should expect the overall portfolio to be in ‘loss” for about two years!

    Let us now compile the data for equity + FD and equity + gilts portfolio (50:50 allocation) in each case.

    • 50% equity + 50% FD: Max Loss with rebalancing: 34%
    • 50% equity + 50% FD: Median Loss with rebalancing: 28%
    • 50% equity + 50% FD: Max Loss without rebalancing: 48%
    • 50% equity + 50% FD: Median Loss without rebalancing: 44%
    • 50% equity + 50% FD: Max time underwater with rebalancing: 27 months
    • 50% equity + 50% FD: Median time underwater with rebalancing: 18 months
    • 50% equity + 50% FD: Max time underwater without rebalancing: 31 months
    • 50% equity + 50% FD: Median time underwater without rebalancing: 23 months

    The benefits of rebalancing are quite clear! If we replace the fixed income with gilts, we get this.

    • 50% equity + 50% Gilts: Max Loss with rebalancing: 31%
    • 50% equity + 50% Gilts: Median Loss with rebalancing: 24%
    • 50% equity + 50% Gilts: Max Loss without rebalancing: 43%
    • 50% equity + 50% Gilts: Median Loss without rebalancing: 42%
    • 50% equity + 50% Gilts: Max time underwater with rebalancing: 22 months
    • 50% equity + 50% Gilts: Median time underwater with rebalancing: 16 months
    • 50% equity + 50% Gilts: Max time underwater without rebalancing: 30 months
    • 50% equity + 50% Gilts: Median time underwater without rebalancing: 23 months

    It is a bit beneficial to rebalance between equity and gilts. Also see return results here: What are the benefits of portfolio rebalancing?

    70% Equity and 30% Debt

    Now the same data is presented for a portfolio with 70% equity.

    • 70% equity + 30% FD: Max Loss with rebalancing: 46%
    • 70% equity + 30% FD: Median Loss with rebalancing: 42%
    • 70% equity + 30% FD: Max Loss without rebalancing: 55%
    • 70% equity + 30% FD: Median Loss without rebalancing: 52%
    • 70% equity + 30% FD: Max time underwater with rebalancing: 27 months
    • 70% equity + 30% FD: Median time underwater with rebalancing: 18 months
    • 70% equity + 30% FD: Max time underwater without rebalancing: 31 months
    • 70% equity + 30% FD: Median time underwater without rebalancing: 23 months

    The same parameters if fixed income is replaced with gilts.

    • 70% equity + 30% Gilts: Max Loss with rebalancing: 45%
    • 70% equity + 30% Gilts: Median Loss with rebalancing: 39%
    • 70% equity + 30% Gilts: Max Loss without rebalancing: 52%
    • 70% equity + 30% Gilts: Median Loss without rebalancing: 51%
    • 70% equity + 30% Gilts: Max time underwater with rebalancing: 32 months
    • 70% equity + 30% Gilts: Median time underwater with rebalancing: 22 months
    • 70% equity + 30% Gilts: Max time underwater without rebalancing: 32 months
    • 70% equity + 30% Gitls: Median time underwater without rebalancing: 30 months

    Due to the dominant equity weight, the difference between FD and gilts have come down. Data for asset allocations will be presented soon.

    In summary, an investor aiming to hold 50-70% equity in the portfolio should expect the portfolio to fall by 35-45% and portfolio losses to persist for 2-3 years. A large loss in time is due to a sideways market and a large loss in value is due to a market crash.

    Only an efficient asset allocation plan with a proper de-risking strategy will fight these losses. If you have not yet done this planning, this is a good place to start: Basics of portfolio construction: A guide for beginners.

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      Pattabiraman editor freefincalDr 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 nine years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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