A couple of weeks ago, the Economic Times published an analysis of mutual fund investing titled 'In equity investment, how long is long term?'. The research compared hypothetical investments in different types of equity funds across different periods in order to find out what is the minimum period of investment one must have if one is to eliminate all possibility of losses, thereby answering the question in the title. The analysis also counted what the chances were of hitting a high enough level of returns over different periods.
While interesting, this approach does not quite align with how individuals should invest in mutual funds. The major tool available to us for damping down losses and enhancing returns in equity-based mutual funds is the Systematic Investment Plan (SIP). To really answer the question of what investors can expect when their investment becomes loss-free, we must do a similar (yet much larger) study on SIP investment. One must simulate an SIP of all possible annual periods from one to ten years for every single month beginning with each fund's launch. From a data analytics point of view, that's a big task, since the number of investments is well above 3 lakh. For each of the investment series, one needs to calculate the internal rate of return, since a simple point-to-point return is meaningless with SIPs.
Value Research being the only organisation in the country with the required expertise on mutual fund data, we obviously decided to conduct this study. How long must your SIP run for the chances of a loss to be minimised? What are patterns of returns and losses when you invest through an SIP? The answers, especially the contrast with one-time investments are quite interesting. In our study, we included 217 equity and equity-oriented hybrid funds that have a history longer than 10 years. We did not include sectoral or thematic funds but only diversified equity funds.
The headline finding of our study was that an SIP investment period of a mere three years meant that the investments had positive returns in more than 90 per cent of the cases. At four years, this was up to 94 per cent. Since this study includes the great crash of 2008-09, these are amazing numbers and a testimony to the fact that this simple technique, available to everyone and in every mutual fund investment, is the only sensible way to invest. Even for a two year investment, which is certainly too short to be recommended for equity investments, positive returns are found in 84 per cent of cases.
The other interesting result of the study was that despite the smoothening effect of SIP investment, the huge variation between funds stays intact. Funds (and AMCs) which have poor investment management are immune to any kind of positive affect, while at the other end, about half the sample is funds whose negative return rate falls to between zero and one per cent for a three year investment. SIP and long-term are not magic wands, choosing a fund with a good fund still matters.
However, all said and done, I would still say that what we found in this study is only a peripheral reason for investing through an SIP in mutual funds. Their real value SIP is not in the maths, but in the psychology. SIPs are the best way of investing regularly and getting good returns without having to constantly worry about whether to invest and when to invest and thus missing out on the best opportunities. When the markets turn downwards, the general instinct of many investors is to stop investing, either because of fear or because they are trying to be smart and catch the bottom of the market. However, SIP investors tend not to do this. More often than not, they continue their SIPs. Soon, the markets go up and this teaches them the value of not stopping their SIPs in bad markets. Thus begins a virtuous cycle, creating a larger new generation of investors who understand the value of regular investing.
All the great returns in the study above were generated because our hypothetical investors did not stop investing. The great value of SIPs lies in how they encourage such behaviour.