Rupee Cost Averaging in a Sideways Market

Whenever there is a discussion on stocks versus fixed income, someone or the other would say, ‘volatility is short-term but growth is long-term.  One can expect the markets to always rise over the long-term.  So buy and hold’.

To this, someone or the other would respond, ‘have you not heard of the Nikkei 225’?  Stop being so optimistic about stocks. What stops the same from happening in India?’

During one such discussion (I don’t remember the details) in the facebook group, Asan Ideas for Wealth, the group owner, Ashal Jauhari, remarked, ‘I would like to see how a SIP in the Nikkei 225 would have fared’. So here goes.

Japan is one strange country. If you keep the money in a bank, you would get no returns!? The current interest rate hovers around zero. That is the banks have a zero interest rate policy.


This is more or less in line with the inflation movement


Notice the extended periods of negative inflation or deflation (thanks to Ramesh Mangal for pointing this out in a different context).

Both these point to an economic recession. The Wikipedia article on deflation, lists the reasons for deflation in Japan, which includes a stock and real estate price bubbles in 1989.

 What ails Japan? is a fine, easy-to-understand article about the whole situation.

According to tradingeconomics, “The Nikkei 225 Stock Average Index is a major stock market index which tracks the performance of 225 top rated companies listed in the First Section of the Tokyo Stock Exchange. The Nikkei 225 has a base value of 176.21 as of May 16, 1949”


source: tradingeconomics.com

Notice that the index has not recovered from the peak of 1989 and is currently close to its 1986 value!  Downward-sloping  oscillations from 1989 to 2003 and then a more flattened sideways movement.

Would the SIP work under such circumstances? Let us find out.

Yahoo Finance lists Nikkei from Jan. 1984. An ongoing monthly SIP of 1000 Yen started in Jan. 1984 would be worth 3,82,130 Yen on 10th June 2014 corresponding to a total investment of 3,66,000 Yen.

A CAGR of 0.28%.

Here is how the investment would have evolved.

Nikkei-1

 

That does not paint a pretty picture does it?

Now let us look at how the CAGR varies for monthly SIPs started in January from 1984 (30 year Sip) to 2014 (6 month SIP!).

Nikkei-2
The CAGR and the year in which it was started are plotted in red (right axis and top horizontal axis). The evolution of the Nikkei is plotted in blue.

For SIP durations of 10Y and more the CAGR is 5% or less. Only recently has the returns sharply picked up. Would it stay that way or will history repeat itself is anybody’s guess.

Here is a curious piece of statistic that I cannot resist sharing at the cost of flogging a dead horse.  I could get hold of monthly MSCI Japan data from the MSCI website.

“The MSCI Japan Index is designed to measure the performance of the large and mid cap segments of the Japanese market. With 320 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Japan” – MSCI.com

Here is how an ongoing monthly SIP started on 31st Dec. 1969 would have evolved

Nikkei-3

 

That looks better doesn’t?

Unfortunately, the CAGR is 2.94% !!

So what? What is the point of this post?  Let us first head back home and then try(!) to answer this question.

Sensex

Here is how the CAGR varies for monthly SIPs stared in April from 1979 (34 year Sip) to 2008 (5 year SIP!).

Nikkei-4

 

  • The Sensex has been plotted on a logarithmic scale (blue; left axis) to display the features conveniently.
  • The red curve represents the CAGR from the start year (red upper horizontal axis) to 3rd July 2014. Notice there is very little spread in returns. That is returns of a 34 year SIP is high and not very different from a 10-year SIP. This, unlike the situation in Japan, is indeed very comforting.
  • Notice the region indicated by the black line. After the Harshad Mehta scandal, compounded by liberalization(?) and unstable governments among others (I am not aware of), the Sensex moved sideways from Mar 1992 to Dec 2002. Thus like Japan, India has had a ‘lost decade as well.
  • A monthly SIP of Rs. 1000 between Mar. 1992 to Dec. 15 2002 would have resulted in a loss. Total investment: Rs. 85,000. Value: Rs. 82,778. CAGR: 0% (that is Excel politely telling you that returns cannot be calculated when the net cash flow (value – investment) is negative!). See more about limitations of XIRR here.
  • A monthly SIP of Rs. 1000 between Mar. 1992 to Dec. 15 2003.  Total investment: Rs. 94,000. Value: Rs. 1,47,303. CAGR: 7.6%. Post-tax CAGR ~ 6.8%. Prior to 2004-05, there was no distinction between long-term capital gains from equity and debt.  Thanks to Sundaram Anathakrishan for clarifying this. Thus, the SIP would have barely managed to beat a 10-year FD started in 1992.
  • Although the Sensex moved sideways, was it all doom and gloom for the Indian stock investor ? That is, did every stock investor suffer? I can’t comment on this.
  • The old racehorse Franklin India Blue Chip did not exactly do well in this period and was highly volatile.

Nikkei-5

 

  • Monthly SIP from 7th Jan. 1994 to 7th Jan. 2002; CAGR = 2.6% (pre-tax!)
  • Monthly SIP from 7th Jan. 1994 to 7th Jan. 2003; CAGR = 5.4%
  • When the sideways period ended, monthly SIP from 7th Jan. 1994 to 7th Jan. 2004. CAGR = 19.96%

At the cost of stating what is obvious by now, SIPs do not work in a sideways market.

Averaging implies the presence of both ‘good’ and ‘bad’. If there is only ‘bad’, the average cannot be ‘good’!!

So what is the point of this post anyway?

When HDFC Equity and Top 200 hit a rough patch not too long ago, it was not gloom and doom for the entire industry. Yes, the market was moving nowhere but many funds, Quantum Long Term Equity, ICIC Focussed Blue Chip, ICIC Pru Dynamic etc. flourished.

Therefore, the investor had a choice to shift to other funds.

What if there was no choice? What if the entire market moves sideways?

Is this possible?  Why not?

Did this happen in Japan? Did no Japanese stock investor make a killing during the last 15-20 years? I do not know.

All I do know is, that we can also have a real estate asset bubble like Japan did. This could well spill over to stocks. We could also have a prolonged sideways market.

Even the eternal optimist cannot hold on to his stocks or funds and sustain a sideways market or a recession forever.

The point is equity investing is done with a certain optimism. Even a die-hard pessimist like me, holds on to this optimism.

However, when the shit hits the fan, optimism is the first out of the door.

Let us look at the ‘Investment in MSCI Japan’ graph again.

Nikkei-3

 

What can you infer from this?

To blindly repose faith in the ‘buy and hold’ strategy will have to be called hindsight bias!

Buy-and hold will work only if the optimism rings true.

I do not think one should invest with bare unprotected optimism.

To protect the fruit of growth and compounding is the single most important task in the accumulation phase once investing begins.

The uncertainty of future market movement is the best reason to focus on goal-based investing:

  • How long will my corpus support me now if I quit my job.
  • How long will my corpus support me if I retire as intended
  • If my net portfolio CAGR in line with my expectations?
  • If it is too high, can I quit while I am ahead and shift to less volatile instrument?

These are the kind of focussed questions that lead to better decision and lower losses.

Should one also adopt tactical asset allocation strategies in-line with goal-based investing?

A look again at the MSCI Japan graph and my answer would be yes.

Easier said than done though! Thankfully not impossible.

What do you think?

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38 thoughts on “Rupee Cost Averaging in a Sideways Market

  1. Krishna Kishore A

    Very nice analysis sir. Yes as your graphs said, SIP will not work for prolonged bear markets. But if we have that patience to sit tight for more years (specially for people in mid 30's), these bear phase can be treated as a accumulating phase. Once the tide reverses, we have our fruits in our hands. (Bamboo tree example recently posted by Ashal Jauhari Ji).

    But what if Japan case repeats in India ? I am not sure sir. Yes asset price bubble may happen here as well (I am pretty sure for the case of RE, not sure about other asset classes). But the major difference which you have probably missed in my humble opinion is difference of economic structure in India and Japan, one is export based and another is import based. Many economic factors changes in this sense, Foreign Reserves, Inflation control, interest rates etc etc will have huge diff b/w these 2 countries. Unless India becomes a major exporter, I don't think we can see negative inflation like Japan situation here.

    Thanks a lot for this wonderful post again from you sir. 🙂

    Reply
  2. Krishna Kishore A

    Very nice analysis sir. Yes as your graphs said, SIP will not work for prolonged bear markets. But if we have that patience to sit tight for more years (specially for people in mid 30's), these bear phase can be treated as a accumulating phase. Once the tide reverses, we have our fruits in our hands. (Bamboo tree example recently posted by Ashal Jauhari Ji).

    But what if Japan case repeats in India ? I am not sure sir. Yes asset price bubble may happen here as well (I am pretty sure for the case of RE, not sure about other asset classes). But the major difference which you have probably missed in my humble opinion is difference of economic structure in India and Japan, one is export based and another is import based. Many economic factors changes in this sense, Foreign Reserves, Inflation control, interest rates etc etc will have huge diff b/w these 2 countries. Unless India becomes a major exporter, I don't think we can see negative inflation like Japan situation here.

    Thanks a lot for this wonderful post again from you sir. 🙂

    Reply
  3. Ramamurthy

    With all this draw backs what is the reason for the Japanese prosperity please?India may not face the same situation as Japan has faced regarding individual investor wealth.I am an Indian individual investor.But I would gladly trade a place with a Japanese investor.

    Reply
  4. Ramamurthy

    With all this draw backs what is the reason for the Japanese prosperity please?India may not face the same situation as Japan has faced regarding individual investor wealth.I am an Indian individual investor.But I would gladly trade a place with a Japanese investor.

    Reply
  5. bharat shah

    though i do not understand much, i like to take Japan's low cagr wrt its o(zero) inflation economy and one should take the dividend yield into consideration , which may be good as share prices are stable and as no growth, the may be distributing the earnings as dividends rather than further employing into business.

    Reply
    1. pattu

      Yes the dividends would probably increase the cagr by 0.5-1% but I am not sure about how regular they were.

      Reply
  6. bharat shah

    though i do not understand much, i like to take Japan's low cagr wrt its o(zero) inflation economy and one should take the dividend yield into consideration , which may be good as share prices are stable and as no growth, the may be distributing the earnings as dividends rather than further employing into business.

    Reply
    1. pattu

      Yes the dividends would probably increase the cagr by 0.5-1% but I am not sure about how regular they were.

      Reply
  7. Deep

    This is an observation on sensex not directly connected to the article.The sensex pe in 1994 was 40+.Hmm..basically a shallow market suddenly exposed to global flows.Obviously investors soon realized they were buying a market way above its fair price.Today even after Modi rally pe is around 19.The sensex long term average is around 18.There r many changes since then.The market size itself is way too deep and diverse compared to 90s which makes such abnormal valuation out of question ,and also the sensex constiuents today are diverse and far deeply integrated with domestic as well as global economy.In 90s even a middle class family spends would mostly be confined to roti ,kapda(non branded),makan(funded by withdrawing pf) and education.Today it has changed dramatically.There will be loans (banks),automobile ownership,branded cloth ,fmcg in short the sensex has today a far deeper integration with daily economic activity and also in a much more diverse way.I am not saying we will not having a sideways or volatile market,but this forum always inspires me to share my observations.It is fascinating how by just observing the index over a period of time u can understand the changes in real economy.The quality of businesses making the sensex today r definitely way better than in 90s .

    Reply
  8. Deep

    This is an observation on sensex not directly connected to the article.The sensex pe in 1994 was 40+.Hmm..basically a shallow market suddenly exposed to global flows.Obviously investors soon realized they were buying a market way above its fair price.Today even after Modi rally pe is around 19.The sensex long term average is around 18.There r many changes since then.The market size itself is way too deep and diverse compared to 90s which makes such abnormal valuation out of question ,and also the sensex constiuents today are diverse and far deeply integrated with domestic as well as global economy.In 90s even a middle class family spends would mostly be confined to roti ,kapda(non branded),makan(funded by withdrawing pf) and education.Today it has changed dramatically.There will be loans (banks),automobile ownership,branded cloth ,fmcg in short the sensex has today a far deeper integration with daily economic activity and also in a much more diverse way.I am not saying we will not having a sideways or volatile market,but this forum always inspires me to share my observations.It is fascinating how by just observing the index over a period of time u can understand the changes in real economy.The quality of businesses making the sensex today r definitely way better than in 90s .

    Reply
  9. Jay Cobb

    Nikkei always pops up to throw a spanner in long term equity planning and brings in a big question mark and "what if" kind of questions. I have been trying to figure out a good hedge against indian MFs to somehow balance out any losses incurred by markets any time. Could you help to understand what is a good investment option that goes in opposite correlation to Indian markets? I think in stock trading one can go short or something in options to hedge against any market drops but what about in MFs? Does such an option exist for an MF investor?

    Reply
    1. bharat shah

      i also like to know. but what a little i understand one can buy 'put' index option to safe guard some of the profits in mutual funds , but i figured out it cost @5-10% for a month or so ( i may be wrong!) and such insurance for 3-6 months may wipe out your gain totally! other better way to select mutual funds used to keep a good cash/debt during such times and be with them. one may postpone further investing beyond nifty pe >22 till come down to 15-18 (any you just decide!) but not to switch the already invested funds unless madness starts (say at nifty pe >25).
      i hope Shri Pattu and others would put their thoughts.

      Reply
      1. pattu

        Put options are quite expensive and not worth it in my view as it is a complex instrument.

        Reply
    2. pattu

      I don't think there are direct hedging options available for Indian mutual fund investors. A well diversified portfolio is the best bet to lower volatility. For tactical asset allocation calls, I cannot think beyond debt at the moment.

      Reply
  10. Jay Cobb

    Nikkei always pops up to throw a spanner in long term equity planning and brings in a big question mark and "what if" kind of questions. I have been trying to figure out a good hedge against indian MFs to somehow balance out any losses incurred by markets any time. Could you help to understand what is a good investment option that goes in opposite correlation to Indian markets? I think in stock trading one can go short or something in options to hedge against any market drops but what about in MFs? Does such an option exist for an MF investor?

    Reply
    1. bharat shah

      i also like to know. but what a little i understand one can buy 'put' index option to safe guard some of the profits in mutual funds , but i figured out it cost @5-10% for a month or so ( i may be wrong!) and such insurance for 3-6 months may wipe out your gain totally! other better way to select mutual funds used to keep a good cash/debt during such times and be with them. one may postpone further investing beyond nifty pe >22 till come down to 15-18 (any you just decide!) but not to switch the already invested funds unless madness starts (say at nifty pe >25).
      i hope Shri Pattu and others would put their thoughts.

      Reply
      1. pattu

        Put options are quite expensive and not worth it in my view as it is a complex instrument.

        Reply
    2. pattu

      I don't think there are direct hedging options available for Indian mutual fund investors. A well diversified portfolio is the best bet to lower volatility. For tactical asset allocation calls, I cannot think beyond debt at the moment.

      Reply
  11. P

    Hi,

    As you mentioned, in case of Japan, since the inflation was negative and interest rates are near 0, even 1-1.5% return is enough, isn't it ?

    Reply
    1. pattu

      Tough to answer. The current inflation is at 4%. Also not many would have invested in equity for that long!

      Reply
  12. P

    Hi,

    As you mentioned, in case of Japan, since the inflation was negative and interest rates are near 0, even 1-1.5% return is enough, isn't it ?

    Reply
    1. pattu

      Tough to answer. The current inflation is at 4%. Also not many would have invested in equity for that long!

      Reply
  13. Sridhar

    Do you consider dividends when you compute the Sensex returns ? While I don't think it would alter the story dramatically, it is going to up the returns a bit.

    Reply
    1. pattu

      Dividends will increase the cagr by up to 2% in the case of the Sensex. Which is significant from the point of view of the corpus but if the base return is small, the total return will not be that high compared to an FD during a sideways market.

      Reply
  14. Sridhar

    Do you consider dividends when you compute the Sensex returns ? While I don't think it would alter the story dramatically, it is going to up the returns a bit.

    Reply
    1. pattu

      Dividends will increase the cagr by up to 2% in the case of the Sensex. Which is significant from the point of view of the corpus but if the base return is small, the total return will not be that high compared to an FD during a sideways market.

      Reply
  15. Karthikeyan

    Sir, thanks for this excellent article. would the results be any different if you used a Flex STP approach of investing, where you buy more when the NAV falls below the average cost of your investment?

    Reply
  16. Karthikeyan

    Sir, thanks for this excellent article. would the results be any different if you used a Flex STP approach of investing, where you buy more when the NAV falls below the average cost of your investment?

    Reply
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