I was going through a data in the investor education material provided by PPFAS Mutual Fund. I found it interesting and wanted to share the same with you.
We repeatedly tell our clients that what matters is buying wisely and then simply staying the course; there is no need to time the market and investing through ups and downs, across market cycles for a long term is the key to create wealth.
Let us assume two investors started investing Rs. 10,000 a month in Sensex from January 1990. They are not smart enough to invest in well performing actively managed funds and have chosen Sensex. They did not choose a fixed date for monthly SIP as they wanted to time the market. They choose the lowest point to enter Sensex every month.
One of them was very lucky and was able to time the market brilliantly. The other person was dumb like me who did not have the capacity to time the market. He ended up choosing the highest point of Sensex to enter.
Decades passed and after 26 years (25.91 to be precise), they wanted to compare their performance on 30th November 2015. The brilliant investor, who always invested in the lowest point of Sensex every month, generated a tax-free wealth of Rs. 2.01 crore. This works out to an annualized return of 11.68%. The dumb investor, who always invested in the highest point of Sensex every month, generated a tax free of wealth of Rs.1.88 crore. This works out to an annualized return of 11.32%. The difference between the returns generated by the most brilliant and the dumb is just 0.36%.
Thus, what matters is the discipline and not how lucky or brilliant you are. In the above example, both acted wisely; diversified portfolio of stocks.
As long as you choose wisely by investing only in open end diversified equity funds (by avoiding closed end NFOs, sectoral or thematic funds or individual stocks), then what matters is discipline of simply staying the course.
I’ve included individual stocks because you need to time the entry and exit for stocks too. Instead, if you choose a portfolio of stocks like mutual funds or index; the fund manager or the exchange automatically takes care of the entry and exit. ‘Buy & Hold’ principle is applicable to portfolio of stocks and would not always be applicable for individual stocks.
I want to tell you one more thing. Your mutual fund portfolio can consist of five or six funds. You need to look only at the overall portfolio performance and not worry about the relative under performance of one or two funds. In any portfolio, some funds would outperform and some underperform in a given year. If you a take a 10-year track record, any good fund would have gone through a rough patch for 3 or 4 years. There is no fund or fund manager who can escape bad years. So it is better to look at 10 year averages. Funds need to be changed only if they consistently underperform benchmark over long run or if there are any major negative events affecting the fund house. Churning the portfolio needs to be very minimal and done only when absolutely necessary.
If you keep churning, your returns would not be equal to fund’s long term returns. Despite being invested, many people don’t make good returns in equity funds because they chase performance. They invest after a few good quarters and redeem after a few bad quarters.
We would be soon entering the 10th year of our profession. Clients who have been with us from the beginning have seen excellent returns for the last 9 years. Their returns are equal to what funds have actually provided. Investor return is equal to investment return. There is no loss or decrease in returns due to the behavioral gap. The same holds good for clients who are with us for 8 years, 7 years, etc.
Only around 2% of investors remain invested beyond 10 years in a fund and reap the benefits of long term compounding. The remaining 98% keep churning, redeeming and lose out on the long term wealth creation.
D Muthukrishnan is Certified Financial Planner at Wise Wealth Advisors.
The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.