Nifty SIP provides 2% real return over 15 years but underperforms Japanese equity by 50%

Published: August 10, 2020 at 12:10 pm

A SIP in the NIfty 50 started 15 years ago would have resulted in a real return of about 2%. A real return is an excess return over inflation and a measure of how purchasing power has been preserved over time. Rather surprisingly a SIP in the Nikkei 225 (flagship Japanese equity index) would have provided a real return of about 4% (in Yen). What is the context associated with these numbers and takeaways? A discussion.

Many of us tend to believe that the NIfty would easily win in any comparison over the Nikkei 225. In a poll conducted at Facebook Group, Asan Ideas for Wealth, 142 out of 188 respondents believed a Nifty SIP would comfortably beat the Nikkei SIP in absolute terms (that is wrt returns in the local currency, without accounting for inflation). Reality is always sobering.

First the objective and context of this study. We are comparing a Nifty SIP over 15 years – 1st Aug 2005 to 7th Aug 2020 with a Nikkei 225 SIP over the same period. The comparison is done in their local currency and local inflation. That is, we are comparing the real return of an Indian investing in the Nifty and the real return of a Japanese investing in the Nikkei 225. The INR-YEN exchange rate is not relevant to this study. Inflation in India and inflation in Japan are extremes in number and nature! This has to be kept in mind while evaluating real returns.

We had just reported that 15-year SIP returns for 71 out of 148 equity MFs is less than 10% and even before the market crash,  ten-year Nifty SIP returns have reduced by almost 50%. Clearly risk premium associated with investing in Indian equities has come down.

Risk premium refers to the extra return an investor expects for taking on additional risk. During the 15-year period considered in this study, PPF returns have hovered close to 8%. We saw in the above-mentioned study of 148 funds only 52% managed to provide a risk premium of at least 2% (10% and above returns). Active fund management cannot be considered for this study as it would be subject to a bunch of biases – hindsight, selection, survivor etc.

Nifty vs Nikkei 225 15-year real returns

A started on 1st Aug 2005 in the Nifty 50 (TRI) would have resulted in a return of 9.84% on 7th Aug 2020. This is a risk premium of about 2%. Not spectacular, not matching dreams investors have, but certainly not too shabby either. The only catch is, almost 1% of that premium, could be eaten away by tax (as per current rules). However, we will leave out taxes for this comparison with Japan.

The corresponding Nikkei-225 (TRI) SIP would have resulted in a return of 6.04% in Yen. That is not bad at all. Things get tricky for both countries if we consider inflation during this period.

Inflation in India

In India, the consumer price index moved from 66.04 in Dec 2005 to 180.44 in Dec 2019, a 7.44% annualized growth! The cost inflation index moved from 117 in 2005-06 to 301 in 2020-21 a 6.5% annualized growth over 15 years.  At this point, we urge readers to calculate how much their own essential expenses have increased over this time.

Computing personal inflation is complicated by lifestyle changes – additions in the family, new devices, habits, medication, additional travel etc. I have previously reported inflation close to 8% during a period when there was no addition in my family and no significant lifestyle change: Inflation in India: Some Real Numbers

Readers may recall this account by Kaustubh Prasad: What 25 Years of Tracking Expenses Taught Me. He was kind enough to dig up his records to see how much his groceries, petrol and electricity bill has increased over this 15 year period with addition in the family and lifestyle change. The average inflation was 9%.

Even if we discount lifestyle creep, the typical increase in expenses over 15 years in India will be higher than the official number of 6.5%. Since it is better to err on the side of caution than optimism, we shall use 8% as realistic inflation in India.

This set the real return from the Nifty at 1.8% (~ 2%). This is calculated as [(1+9.94%)/(1+8%)]-1. Again tax will reduce the real return to about 1%. Is this any good? It is probably less than what most investors expect, but it is quite acceptable for those who invested enough from the start after planning right. The catch is, investors expect more premium because they do not have enough to invest!

Inflation in Japan

In Japan, the consumer price index moved from 97 (approx) in 2005 to 102 (approx) in 2020, resulting in an inflation of 0.34%. While India has been fighting inflation, Japan has been fighting deflation for the most part of the 15-year period studied. It recovered to some extent from 2013 onwards but the pandemic could spell trouble again. See: Deflation fears creep back in Japan as pandemic hits prices and The Scourge Of Deflation Returns To Japan

Sustained demand-driven economic growth in Japan has been a nightmarish problem for its govt and central bank (refer above links). Low inflation should not be confused with the low cost of living. Tokyo is the third most expensive city in the world according to a Mercer study. The first on the list is Hong Kong and the second, would you believe, Ashgabat in Turkmenistan (hyperinflation is one reason). Mumbai is 67th, New Delhi 101st, Chennai 143rd, Bengaluru 171st, Kolkata 185th.

Low inflation in the case of Japan only means its cost of living has remained at the same level (high) for more than two decades now. The 6.04% 15-year Nikkei return would result in a real return of about 4% – before tax assuming inflation + lifestyle creep of 2% in Japan. This is twice as that for Nifty and certainly a good number, but a little more perspective is necessary.

If a Japanese investor had kept faith in the Nikkei-225 for those 15 years, the “real reward” would have been spectacular – twice as that for an Indian investor. If we compare a normal middle-class spender in both countries – neither miserly (not to be confused with frugal), nor extravagant, who is likely to have more money on their hands to invest? Naturally, this depends on which city/town they live and many other factors.

The answer to this question will determine how much an investor has exploited this real return. It is beyond our scope to provide even a guesstimate for this complicated question. All we can say for sure is the following.

Nikkei-225 has provided approximately twice the real return than Nifty over the last 15 years. How much of translates into actually spending power depends on how much they invested. Although equity participation in Japan is a good 15% (at least 10 times more than in India, though country size matters), their constant high cost of living (at least in major cities) could be or would be a big detriment to putting significant money into equity “for the long term”.

In India, the challenge is to find funds to invest in equity after fighting an ever-increasing cost of living. In addition, we will also have to appreciate a significant reduction in equity risk premium and taxation.

Finally, in my opinion, an Indian investor who had the ambition to change her social station and the associated consistent risk-taking ability would probably be “richer” today than a corresponding Japanese investor. If there is only one takeaway from this study it is, take risks when young (meaning hold significant equity), invest as much as possible, keep expectations low and manage the risk intelligently.  That way, even if the real return is zero or negative in future, we would have enough money to handle future expected and unexpected needs.

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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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