On Aug. 25th 2014, the Economic Times carried an article titled, PPF investment can beat Sensex returns over 20-year period. They showed that between Aug. 1994 to Aug. 2014, Sensex returned an annualized return of 9.15% while the PPF returned 10.46%.
Needless to mention this article created a lot of buzz among investors and distributors. Investors panicked and wondered if they were right to have started that SIP a few months ago.
Five days later, the distributor portal CafeMutual carried an article (Can PPF beat Sensex returns over 20-year period? ) whose sole purpose was to debunk the Economic Times article.
The CafeMutual article pointed out that only one time period was considered by the ET correspondent and that dividends from the Sensex were ignored.
Therefore in order to disprove the ET article three different dividend yields were added to the Sensex CAGR of 9.15% to ensure it is higher than PPF.
Now everyone can rest easy. Equity is the better instrument! So why write another post on the subject?
Fair question. Let us begin by quoting some important lines from the ET article which seems to have escaped the attention of those who found it troubling."While this study is no suggestion that a PPF is a far better option than equities at all times, it just reinforces the fact that timing is critical in the capital market. Despite the recent rally, Sensex's annualised return for a period of seven years is only 8.10%, if you have entered at the fag end of the previous rally (i.e., in August 2007)." "....retail investors who are entering the ring now need to be mindful of the fact that they may not get the kind of returns from equities as seen in the recent past. In some instances, it also doesn't make much sense being a long-term investor in equities"
Amusingly, the Cafe Mutual article has the following to say:
Then it goes on to state, "PPF investment can beat Sensex returns over 20-year period - it can, but not this time…" (in the above mentioned period)
Now let us satisfy our curiosity by looking at all possible 20 year CAGR constructed out of Senex returns for all financial years from 1979-80. The period covered is different that considered above, but that should not make too much of a difference.
This chart was constructed with the Excel sheet available at: Understanding the Nature of Stock Market Returns
A notional 2% dividend was added. It does not matter though. I think it is safe to say that PPF has beat the Sensex over only one 20Y period (the one surrounded by a green rectangle).
So shall we rejoice? Rest easy and assume that our equity SIPs will definitely beat PPF returns? Shall we emphatically state that equity will beat returns from fixed income instruments?
Not so fast. Do so at your own peril.
Let us assume you will have to pick a stone, eyes closed, from a box containing black and white stones. Pick a white stone, you win. Pick a black stone you lose. History suggests that white stones were picked more often than black stones.
I cite this fact and persuade you to pick a stone. Will you pick with the confidence that you cannot lose because most people who have picked in the past have not lost?
Equity investing is not very different.
Notice the spread in the above returns. The maximum return (before dividends) is 20% and the minimum return is 7%.
So clearly the return depends on when the investment begins. It does not matter whether it is a lump sum or SIP. In equity investing, the sequence of returns determines the final returns. This is crudely referred to as 'luck' or 'market timing'.
This is the main message of the ET article: returns depend on when you start investments. Sometimes one can beat PPF and sometimes not. Past performance is irrelevant.
If I were a mutual fund distributor, I will choose to ignore this fact. Since I am a retail investor, I cannot afford to ignore it.
The huge spread in returns observed in the past is the reason why equity investments must be regularly monitored and course-corrected.
It is beyond naive to assume that letting a SIP run in a mutual fund for years will get the job done.
Comparing a fixed income instrument with an unmonitored equity instrument serves only one purpose: It serves as a reminder that volatile instruments must be monitored!
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