Why do investors fail to generate wealth through SIP?

It is observed that most of the investors who initially opt for the SIP with a long-term view, stop their SIPs in the first 3 years only and therefore fail to create real wealth. The obvious reasons for their SIP discontinuation are:

a)    Non-performance of the fund

b)    Negative or flat return

c)    Comparing FD returns with a subdued return of SIP

d)    Require funds for other purposes

e)    Panic exit due to market fall

f)     Not finding value (reason) to continue future SIP

Investors fail to understand that SIP investment is a long term commitment like an insurance policy and one should not seek a return in the initial phase of 5 - 10 years. There are numerous benefits associated with SIP, unfortunately, investors fail to access: 

• Rupee cost averaging i.e. to capture more units when the market falls
• Curb market volatility as one continues to buy at a fixed interval over a period of time
• Power of compounding starts playing in long term and actual benefit could be seen +15 years afterward
• No need to inject a large amount at one go. Small contributions over a period of time convert into a big giant
• Convenient investment option – amount directly auto-debited from Bank on a predefined date
• Makes market timing irrelevant
• Disciplined way of investing 

Most investors expect a SIP return in a similar fashion to FD. There is a basic difference between the two. FD provides guaranteed and linear return under which you know what would be the maturity value from day one. On the other hand, there is no assured return under SIP, and performance is based on market movement; therefore, returns are always variable.

 Conclusion:

• One should not look at the current portfolio value on a frequent basis and stick to their long term goals. The focus should be on accumulating more and more units per month basis

• Since SIPs are aimed at helping investors meet their goals, it is important that they continue their SIPs till their goals are achieved in an uninterrupted manner

• When the market falls under the bear phase or sideways movement for prolonged periods of time; that is the time to keep patient, maintain consistency and have conviction 

• In fact, if SIP fails to generate a return and when its market value is less than the principal amount, the time has come to double your SIP amount to reap the extra benefit later

Disclaimer: Mutual Funds investment are subject to Market Risk

The illusion of CAGR - part II

In continuation of my previous blog – part I, investors prefer consistency in return and not volatility. However, risk can be mitigated to some extent if investors are consistent in their own investments first for more than a decade rather than seeking a consistent return, and further strictly follow asset allocation simultaneously, which contributes to 90% of the return in the overall portfolio. 

The formula for CAGR is derived from the power of compounding formula:

Fv = Pv * (1+R) ^ T

R = (Fv / Pv) ^ (1/t) – 1

(this is a point to point investment formula and not recurring formula for SIP) 

Out of the three variables (Pv, R & T), what is in our hand is the Principal amount to deploy, and the Time period for which we invest. Returns are never in our control, however, the majority of investors only focus on getting the highest return. The most powerful variable among the three is Time, which is usually ignored by the investor.

One must also understand that there is a basic difference between secured instruments like FD and market-link products like equity MF. One should not compare an Apple with an Orange. FD can never give an inflation-adjusted return, whereas equity MF can not deliver linear returns like FD on a year on year basis. FD is guaranteed hence returns are low, and equity MF is volatile hence return are high.

Although despite having a 12% CAGR return for 10 years in following both cases, there could be much interim volatility in the case of equity investments.

Expectation
Year	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019	CAGR
Return p.a.	12%	12%	12%	12%	12%	12%	12%	12%	12%	12%	12%
Reality
Year	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019	CAGR
Return p.a.	21%	-31%	34%	6%	102%	28%	5%	41%	-22%	-12%	12%

• Therefore, the CAGR is the average rate at which the investment amount has grown from one value to another from the start point to the endpoint.
• The problem or anticipation here is that the growth of the investment amount is not at a constant rate. As seen from the given example rate deviate from -31% to 102%.
• By quoting 12% CAGR for 10 years, it hides the interim volatility of the scheme and makes an illusion of steady growth year on year.
• Investor must be aware with year on year fluctuation in return, volatility, standard deviation – all are termed as Risk in layman terms. 

Do investors always get into the trap of investing just by seen past performance i.e. only return parameter and fail to understand the volatility of the scheme on either side - positive or negative?

The illusion of CAGR - part I

By definition, Compounded Annualized Growth Rate (CAGR) is per annual return compounded annually and used for calculating the return over a one year period. 

For example, if the return in any particular scheme of a mutual fund or stock for the last 5 years is 12% CAGR, which means if Rs. 1000 had been invested 5 years back, now its value became Rs. 1762. However, the misconception among the investors is that the growth of 1000 to 1762 has happened in linear fashion i.e. every year the return was generated @12% p.a. whereas actually, CAGR does not indicate the growth of funds in a straight line manner like FD.

In reality, per annum growth could be much higher, lower, or around 12% in any of the periods in between during the investment phase. This also means the growth rate could be positive as well negative in some of the years and even than 5 years CAGR could be 12%. Here investor fails to understand this fluctuation (volatility) in market-linked instruments and believe that equity investment has high potential to deliver but ignore the risk of getting a negative return or subdue return during interim years. 

Most investors don't mentally prepared to get such high volatility/fluctuation in investment returns on day to day basis and therefore failed to stick with a particular scheme if they don't see positive returns for a prolonged period of time and prefer to get out of the scheme even if getting loss.

You can see from the below mentioned seven examples, rate of return is the same which is 12% CAGR for 5 years, but the fluctuation on year on year basis is drastically different and the risk associated with a negative return is always ignored by the investor. Although in the long-run equity market always return back to its mean average despite volatile fluctuations.

Year	Principal	Rate	Interest	Total
1	1000	12%	120	1120
2	1120	12%	134	1254
3	1254	12%	151	1405
4	1405	12%	169	1574
5	1574	12%	189	1762

Year	Principal	Rate	Interest	Total
1	1000	-40%	-400	600
2	600	27%	164	764
3	764	32%	245	1009
4	1009	42%	424	1433
5	1433	23%	330	1762

Year	Principal	Rate	Interest	Total
1	1000	4%	40	1040
2	1040	-25%	-260	780
3	780	48%	374	1154
4	1154	29%	335	1489
5	1489	18%	273	1762

Year	Principal	Rate	Interest	Total
1	1000	18%	180	1180
2	1180	27%	319	1499
3	1499	-20%	-300	1199
4	1199	30%	360	1559
5	1559	13%	203	1762

Year	Principal	Rate	Interest	Total
1	1000	19%	188	1188
2	1188	0%	0	1188
3	1188	-10%	-119	1069
4	1069	-30%	-321	748
5	748	136%	1014	1762

Year	Principal	Rate	Interest	Total
1	1000	10%	100	1100
2	1100	15%	165	1265
3	1265	25%	316	1581
4	1581	35%	553	2135
5	2135	-17%	-373	1762

Year	Principal	Rate	Interest	Total
1	1000	8%	80	1080
2	1080	10%	108	1188
3	1188	12%	143	1331
4	1331	14%	186	1517
5	1517	16%	245	1762

In all the above cases, we get the same result - an investment of Rs. 1000 and getting the maturity of Rs. 1762 after 5 years at 12% CAGR. What makes the difference in the process of achieving that result. that investors need to understand before making the decision just only on a return parameter!

Step 8: Review & Rebalance your Portfolio

Last but not least is Review & Rebalance your Portfolio which comes at step no 8. 

Once you have followed all previous steps religiously and created your portfolio, now the only thing is remaining to review your portfolio at a regular interval of 6 months or 1 year thereafter. And what you are going to do in review... rebalancing your asset allocation to maintain the original allocation i.e. you have to follow static asset allocation ratio.

Understand that money never sinks in mutual funds. If we are not able to generate a return or getting loss on the principal amount, probably we have not followed all these mentioned 8 steps process thoroughly. Remember, MF scheme selection is the sixth step to execute and most of the investors make a blunder by skipping the first five stages.

One can also take the help of a Certified Financial Planner to guide you properly and assist you to maintain Asset Allocation over a period of time to generate a return consistency. 

 

 Disclaimer: Mutual Funds investment are subject to Market Risk

Step 7: Start Early

Step 7 indicates it's time for taking action now. As a human being, procrastination is very common and we keep on delaying taking action until it becomes urgent. We don't do things when it is important but we trigger the action only once it becomes very urgent. Investment is important, we all know but we only invest until it falls into the critical category.

Time is the most important element not only in life but in investing as well. Unfortunately, most people don't realize the Time Value of Money and that is why they fail to create wealth. People chase (focus) on the return which is never in our hands, what is in our hands is a time horizon and principal amount to deploy. 

For Target of Rs.5 crores at the age of 60 @ 11% p.a. your monthly saving amount should be …

A small SIP of Rs. 10,000 investment for 30 - 40 - 50 - 60 years can do miracles. Actually, we never ever target 10 crores or 100 crores in life and that is why we don't even get it.

Investment is also for creating a legacy for the next generation, which only rich people do.  

Disclaimer: Mutual Funds investment are subject to Market Risk
 

Step 6: Select the Right Product & Scheme

The next step comes to Selecting the Right Product & Scheme once you have decided your asset allocation.

Most of the investors straight away go on to select the scheme based on the historical returns and skip all stages already mentioned previously. They ignore the very basic fact that the past performance of the schemes does not indicate future performance. This leads to frustration eventually when their investments don't perform as per our expectations. 

(A) PRODUCT SELECTION

Once you have performed the earlier steps, you are now clear about your investment objective, time horizon, and risk-return expectations. It is now easier to match one's investment objective with the various schemes and determine the right mix of products available to you. 

 (B) SCHEME SELECTION

In a mutual fund, we have different categories:

• Equity Fund – Largecap, Midcap, Small Cap, Multicap, ELSS, Value Fund, Thematic, Sector Fund, Dividend Yield Fund, Index Fund
• Hybrid Fund – Aggressive Hybrid, Balanced Advantage Fund, Conservative Hybrid, Asset Allocator Fund, Multi-Asset Fund
• Debt Fund – Liquid, Ultra-short Term, Low Duration, Credit Risk, Gilt, All-season Bond, Floater Fund

So within the asset class category again it totally depends on your need, financial goal, time horizon, and risk appetite. One should match scheme objective, investment philosophy & investment option

It is a study of respective scheme objective and their investment philosophy within the chosen asset class.

Disclaimer: Mutual Funds investment are subject to Market Risk

Step 5: Diversify across various Asset classes

After going through the first 4 steps, nest one is Diversify across various Asset Classes. 

We all know that never ever put your all eggs into one basket. So if you have Rs. 100 to invest in, diversify it in different asset classes based on your risk profiling, investment time horizon & future financial goals. Each & every asset class has their own nature, property and one should know all pros & cons before investing.

Some of the risk associated with various asset classes are: 

Inflation Risk - Cash & Debt

Liquidity Risk - Insurance & Real Estate

Principal Risk & Volatility Risk - Equity

High Tax at maturity - Debt

Currency Market Risk - Gold

Encroachment Risk - Real Estate

One can create asset allocation by choosing from equity, debt, gold, cash, real estate & insurance. Your portfolio needs to be properly diversified as asset allocation reduces the downward risk of the portfolio to the great extent. Since all asset classes behave differently during different market conditions, they act as a hedge against each other and help in creating a good margin of safety.  

However, remember if you are boarded with 100% equity exposure, then you are carrying high principal risk in the short term. And if you prefer to go with a 100% secured debt instrument, then you carry high inflation risk in the long term.

A Mutual fund is the only platform in India that cater to the need of saving + investing both.

Diversification plays a key role in wealth creation

Step 4: Understand your Risk Profile

Risk Profiling comes at the 4th step and supposed to be the backbone of your all investment decisions. However, 90% of investors just ignore this important step and go directly into the investments without knowing their risk appetite, which eventually converts into huge losses over a period of time. 

Risk profiling works on human phycology, behavior finance, and mindset which contributes 80% towards your return. It is essential because investor psyche and investor behavior play an important role in long term returns. Market se paisa nahi banta – Midset se banta hai!

An investor could be belong to any of the following categories:

 - Conservative

- Moderate, or

- Aggressive

A typical conservative investor could panic during volatile markets and might sell his units/shares at the worst time which is usually the bottom of the market. An aggressive investor on the other hand would be comfortable in a riskier asset class which can give higher returns but carry high risk (volatility) too. Once you have understood your risk profile, the task of scheme selection is easier as you can match your return expectation with the scheme's objective.

Everyone needs a high return, but for that how much risk one can digest, is also need to understand. Therefore, know your Risk Appetite & Rerun expectations before investing.

Layman के हिसाब से समझे, कि अगर मै ४ रोटी खा लेता हूँ लेकिन मै २ रोटी ही digest कर पता हूँ तो मेरे को हेल्थ से related प्रॉब्लम होना तय है. This golden concept is applicable to investing as well. High Return सबको चाहिए होता है लेकिन उसके लिए कितनी Risk digest कर पाते हैं, ये important है

A risk profile works as a barometer to match an investor's risk appetite & return expectations.

 

Step 3: Define Investment Time Horizon & Set Priorities

Time plays a very important role not only in our life but also in scheme selection. Unfortunately, many investors do not have a clear idea when actually they need their money back and that is why they end up buying the wrong scheme always. 

After identifying your Financial Goals, the next 3rd step is to fix your Investment time horizon & set priorities. One can divide their goals into 3 groups

• Short Term (1 day - 3 years)
• Medium Term (3 years - 5 years)
• Long Term (> 5 years)

You should be very clear about your financial needs/goals. After defining your investment horizon, the next step is to set priorities from scale #1 to #10 where scale #1 high priority & scale #10 lowest priority. It's equally important to fix the priorities if you have multiple goals which all of us usually have. Start investing for your topmost 5 priority goals first whether it is short-term, medium-term, or long-term.  

The time horizon will also indicate you when you should book profit from risky asset class much before you actually need the money in the future.

 

Step 2: Identify Your Financial Goals

After doing your need analysis, the 2nd step is to identify your Financial Goals. Just like you have fixed various Goals related to other streams of life, it's equally important to fix Financial Goals in writing.

A large number of people don’t invest in keeping their financial goals insight. One can have single or multiple financial goals. Most of us have more or less common goals in life for example retirement planning, children’s education & marriage, buying a home, vehicle purchase, medical emergency, vacation, or any other family obligations. Buy fixing goals, you come to know the future target amount to be required and that should be inflation-linked always. Its means value of 1 crore after 20 years would be equal to appx. 25 lacs of today.

 

 Identifying financial goals provide your investment purpose & target amount.

Step 1: Know Your Investment Criteria

To start with, for creating your winning portfolio basket, the first steps is Know your Investment Criteria i.e. your need analysis

The very first thing you should ask yourself why you want to invest, the motto behind your investment decision. Your criteria could be based on:

• Growth / Capital appreciation
• Safety / Capital protection
• Regular income generation
• Want to save Tax u/s 80C
• High post-tax return
• Liquidity needs as & when required
• Beat Inflation
• or any specific criteria/objective

This is a very important step that creates a base for your further investment process. Unfortunately, most of the investors are not clear or vague about their own investment needs and therefore take the decision purely on the market/scheme performance.

You as an investor must understand your own need & cash flow requirements. Define it clearly as it plays a very important role in finalizing scheme selection. Once you have chosen one or more than one criteria, then go to the next Step 2. (read next blog)

Do need analysis first!

Know 8 Steps Process on How to Create Winning Portfolio Basket

Whenever you invest in mutual funds, always get confused about which scheme to select, which one is better, and which scheme will offer the highest profit & lowest risk. Although scheme selection is important, however, there are other important factors as well which investor generally ignore and incur capital losses after investing in mutual funds

In India, there are 44 AMC that offer more than 3000 schemes to their investors. However, the investor is more interested in knowing which scheme is top-performing or the highest return generating scheme rather than finding out the scheme which suits their individual requirements.

Therefore, some homework and planning are important before investing in Mutual Fund. There is 8 steps process to build your investment portfolio basket through mutual funds. These eight steps are:

1. Know your Investment Criteria - need analysis
2. Identify your Financial Goals - the purpose of your investment
3. Define Investment Time Horizon & Set Priorities - when you actually need money
4. Understand your Risk Profile - match your risk appetite vs return expectation
5. Diversify across various Asset classes - understand the nature of the asset class
6. Select the Right MF Scheme - know the scheme investment philosophy
7. Start Early - time for execution
8. Review & Rebalance your Portfolio - 90% return generated from this step only

W(will write stepwise in details in my next blog)

Conclusion: 

• Money never sinks in mutual funds. If you are not able to generate a return or getting a loss on the principal amount, probably you have not followed above mentioned 8 steps process religiously.
• MF scheme selection is the sixth step to execute and most of the investors make a blunder by skipping the first five stages.
• One can also take the help of a Certified Financial Planner to follow the above steps and also require to maintain his Asset Allocation over a period of time to generate a return consistency. 

Disclaimer: Mutual Funds investment are subject to Market Risk

Should I Stop My SIP?

When the market correct or undergo with bear phase or sideways phase and when SIP (Equity) returns are negative to a flat, lot many investors have many concerns/doubts/queries about their SIP like:

 ·  Should I continue with my monthly SIP?

·   Is it wise to stop & redeem all SIP to curtail further loss?

·  I have been investing via SIP for the last five years with no return, for what duration should I continue my SIP further?

·  Considering the current market scenario, would it be better to decrease the SIP amount for the time being?

·   Should I change the SIP scheme that has not done well? How to deal with loss-making SIPs?

·   Can I take SIP pause for the next three / six months till the market improves?

·  I need money, should I withdraw from my SIP account?

·  I am scarred by negative returns & huge accumulated losses. What should I do? How I will create wealth?

One should understand that equity markets usually undergo several ups & downs, and in some of these times, they are bound to see negative returns. SIPs in equity funds are generally done for long-term goals such as retirement, kid’s education & marriage having a time horizon of at least 10 years. Therefore, by design, SIPs are capable of withstanding all kinds of corrections in the market, even sharp corrections such as the one we faced recently in Mar’2020. These corrections will only help investors to average out purchase costs. Hence, to make the best of the situation, one should continue with SIP and if possible increase your SIP amount.

In the past 40 years, there have been seven major correction/bear market periods with a fall of the market around 40% to 60% from the top. Time taken from peak to trough is anywhere between 4 months to 2 years and similarly, time taken for recovery ranges from 6 months to 2.5 years.

·         Year 1992 - Sensex down by 54% in a year and up by 127% in the next 1.5 yrs.

·         Year 1996 - 40% down in 4 years and 115% in the next year

·         Year 2000 - 56% down in my 1.5 years and 138% up next 2.5 years.

·         Year 2008 - 61% down in 1 year and 157% up in the next 1.5 years

·         Year 2010 - 28% down in 1 year and 96% up in the next 3 years

·         Year 2015 - 22.3% down in 1 Year and 25% up in the next 7 months

·         Year 2020 - 40% down in Mar’20, then recovered and hit an all-time high in Nov’20

One should never make investment decisions on the prevailing market conditions. A SIP allows you to buy mutual funds units regularly. The basic idea of investing through SIPs is to invest in a disciplined way without getting influenced by the highs & lows in the market. It is strongly suggested to continue your SIPs during the bear phase, help you average at lower levels. Please do know that buying cheap is the essence of getting higher returns and therefore keep investing in the SIP way. Use every dip to increase equity allocation gradually as per your risk profile. Don't try to predict the bottom, which will come & go. Equity investments are all about conviction, discipline & patience. It always payout in long term but one has to undergo short-term pain. Focus to maintain your asset allocation.

Conclusion:

• The best way to address this issue is not to constantly watch the portfolio until the market settled down.
• Never put your emergency fund in equity SIP
• Stick to your asset allocation and remember that in the long run, it's only asset allocation strategy that defines the returns you generate. Focus on your asset allocation & future goals only.
• Stopping SIP would be a grave mistake – don’t do that. It is really a very bad time for stopping SIPs during the correction phase.
• Equity is a unique asset class where the majority of investors are comfortable buying at High & selling at Low, thus never able to create wealth. Whereas SIP is a long term commitment like insurance policies. 
• Remember investments made during the toughest time yielded the best return over a period of time and investments made during good time yielded not so good return.

Disclaimer: Mutual Funds investment are subject to Market Risk