Mutual funds / SIP / Equity investments are more about relative returns rather than absolute returns. The right question to ask is not “how much you will get” but “whether it is better than the other options you have”.
I am assuming that the SIPs you are talking about are Equity SIPs. These prove to be better than most options retail investors have due the following two reasons: A, it is an equity investment. B, it is a systematic investment. I will elaborate on both of these.
A. Equity Investment
- Risk over time: If you google a bit, you will find tonnes of charts that will show you how over a longer period equity investments tend to outperform most other types of investments. The key here is “over a longer period”. Equity investments are not fixed return investments. Over a shorter period they can give you losses as well – but to you need to give your market investments time to recover should this happen. Ideally, equity mutual funds are a great place to grow your wealth. And growing wealth takes time, it doesn’t happen overnight. [We are not talking about gambling or being on a magician’s stage here 🙂 ]. So, if you have a short term horizon, ideally don’t consider investing in equity SIPs.
- Equity and business: You must understand that investing in equities effectively means taking an ownership in a company. Now if you were to invest in your own business idea, would you put your money in it if it were to give you the same 7–8% return as FDs? You would look at at least a 12% return (most likely 15%) for the risk you are taking, isn’t it? So theoretically, businesses should pay you more than FDs. However, a lot of businesses do go bad. So practically, this can only be achieved if you are constantly identifying and selling off bad businesses to buy other better businesses. And this is where a mutual fund comes in – the fund manager does the work of constantly improving the quality of businesses in your portfolio.
- Equity and economy: If you you invest in an SIP portfolio of 2–3 funds, you most likely will own businesses (good ones) from across different sectors of the economy. Now theoretically, the only scenario that such a portfolio will not give you decent money over a 10 year period is if India doesn’t grow as an economy in this period. (If India doesn’t grow, the businesses don’t grow. If businesses don’t go, the value of your ownership doesn’t grow).
B. Systematic Investment
- Value of a “System” in investing: If you google a bit, you will find tonnes of research that has shown time and again that the best way to make money and mitigate risks in investments, is to develop a system and follow it no matter what. An SIP is one of the easiest such system available to retail investors.
- Averaging: When you invest a fixed amount periodically in a volatile avenue like equities, it helps you average out your investment price over time. You end up buying more units for the same money when markets are low and less units for the same money when the markets are high. This fine tunes the average cost at which you have been purchasing units.
Having said this, equity markets have given about a 15% return in the past – and funds a little more than that. Just because they gave that in the past doesn’t mean that you will get the same in the future. If I were you, I would make my financial plan based on a more conservative 12–14% expectation. (This is still better than most other options available!)
The below table shows you how much money you would end up with at different levels. If things go good and India grows well you may land up in the bottom few rows. If I were you I wouldn’t plan an equity SIP for the first two columns.
You must remember that there is no guarantee that the returns will fall in this range. Theoretically, you can also get negative returns.
Hope this helps!
Regards,
Anirudh Sheth, CFA
(P.S. I am an ex-London based investment banker. I am a strong believer of mutual funds and have most of my own wealth parked in mutual funds. Currently, I advise clients on managing their mutual funds investments & personal finance in Mumbai. I am also a CFA charterholder.)
