#SIP9WoW – If compounding is the eighth wonder of the world then SIP is the ninth

#SIP9WoW – If compounding is the eighth wonder of the world then SIP is the ninth

Note: The blog is a little lengthy but a breezy read. Views expressed are personal.

SIP refers to Systematic Investment Plans which is specific amount being invested at a regular date. 

One of the benefits of being born in a Gujarati family is that you are exposed to finance very early on in life. When I was in the 5^th grade (10 years old) I started going to the bank with my dad to update the passbook of my minor account and create a recurring deposit. My Dad would then ask me to check if the eventual interest matched with the rate of interest promised. I don’t know if it’s got to do with the genes but I always had a passion/inquisitiveness for finance. Over a period of time I would take my Dad’s equity statement and read up on some of the companies he held. While I had little understanding of B/S, CF, P&L etc I would read up on what these businesses were, whether they were B2C/B2B, did people crave for the end product, was it a manufacturing or a service company etc etc.

Jump to Jan 2006 I joined Edelweiss on their Institutional Research Desk. It was dream come true. I felt similar to a small kid who was yearning for a small chocolate and discovered a whole chocolate mountain. I was awestruck by the way equity markets operated, how research was done, how many ideas were generated. While building up my knowledge on equities and on investing in companies I was exposed to the ideal of Mutual Fund SIP. While I had read up and heard about Mutual Funds I had little idea about SIP’s apart from the standard rupee averaging. It’s not that most of us at that stage were not aware of MF investing we just thought it was for lesser mortals. Here we were in one of the fastest growing domestic brokerage in the country with a very strong research team; I thought to myself that ill surely beat the returns of these mutual funds.

However from a very young age my dad had taught me that’s it’s very important to save a portion of your income to create future cashflows and for a rainy day. The traditional way would have been a recurring deposit with the bank; however through 2003 to 2008 we were in the midst of a massive bull market in India. MF returns in the popular schemes were running at 15-30% annualized return. So I thought to myself that it will take me at least couple of years to build my understanding on businesses in the meanwhile why not start a MF SIP just to experience how it goes. Since we were starting out our careers its sufficient to say that our pay scales were fairly modest. Competing with MF SIP were our desires to spend on better clothes, better travel, better restaurants and better lifestyle (don’t think you can hold these things against any kid who is starting out his work-life and has dreamt about these things all through his childhood). Within this tussle of better lifestyle and some savings, the Gujarati in me won a semi-battle and in May 2006 I started my first SIP in Fidelity Special Situations Fund. There was absolutely no research backing this.

And the party lasted for a while as we hit 21k or there about in Dec 2007/Jan 2008. Along the way propelled by a raging bull market Reliance Diversified Power, Reliance Vision etc made debuts in my MF portfolio. Amounts were largely miniscule with SIP’s of Rs.1000/month but I still felt good as I was saving and returns were largely beating the 6-9% recurring deposit threshold. However in the period of Jan 2008 and Dec 2008 Global Financial Crisis hit stock markets across the world with most markets losing anywhere between 30-70%. India was no different from a peak to 21k we fell to 7-8k (numbers are not that important). And all the advantages of rupee averaging were thrown out of the window as educated finance professional stopped their SIP’s. I was in a fix. I had read that rupee averaging was the biggest benefit of SIP and ideally we should be happy that stocks were correcting which meant NAV’s (MF price for simplicity sake) were correcting. With just 2 years into your career, with hoards of people panicking and some of the stalwarts saying that they had never seen something like this ever in their career meant that your conviction gets seriously tested.

I prevailed. I dint stop my SIP for 2 reasons 1)at that stage I dint contribute anything to my household expenses which meant that I wasn’t stretched for finances and hence could go through the turmoil a little longer 2) I have always been an extreme bull on India and Indian stock markets. When the world panics that’s your biggest opportunity. Also the amounts involved were not very large on a monthly basis for me to panic. I remember having a conversation with couple of my colleagues around that period who said why waste capital in MF why not take long futures contract on Nifty at 20% cost and ride the upside. Both of them dint put a single penny in any form in stocks or mutual fund before we started roaring again in May 2009 when Congress came back to power in thumping fashion. I was happy that my persistence with SIP will eventually pay-off.

GFC taught me the most important lesson in investing while it’s important to be with fundamentals the biggest deciding factor of how successful you are is the ability to control your human side. We all are greedy when the going is good and we all are fearful when the going is tough. People who are able to operate otherwise even at the margin are really successful investors. And then there is another way to overcome this which is through MUTUAL FUND SIP which is why I call it SIP – The ninth wonder of the world. Before we get more into specifics of MF SIP I would like to spend some time on basics of finance/investing/wealth creation.

My dad hates mutual funds for 2 reasons 1) he feels a well-informed individual can easily outperform them and 2) his view is also clouded by mis-management that we saw in erstwhile UTI.

The core of wealth creation is asset allocation. Most people get their asset allocation horribly wrong. 2-3 key things which I have learnt about wealth creation and asset allocations are

1)     Start early – Start saving early so that the effect of compounding money over a long period of time can play out

2)     Small Amounts – Most of us struggle to make ends meet in initial years of our work life. So start with however small amount as may be Rs.100/Rs.200/Rs.500

3)     Spend time on asset allocation – Most of us don’t spend even 10% time on asset allocation which it ideally deserves. In my view, if you make the right investment decision that can impact 75% of your eventual wealth creation vs only 25% your income. Rs.100 invested at 8% compounding in fixed deposit will give you Rs.216 at the end of 10 years (I have taken the liberty of compounding on FD which might not necessarily be true) while the same money if it can be invested in a share or MF at 15% would lead to Rs.405. So we are at 2.16x in FD v/s 4.05x in Equity/MF without even considering any tax impact.

There are 2-3 key mistakes that people make in Asset Allocation and Financial Planning in general

1)     Spend and Save – Most people spend and then save what is remaining while it should be the other way round. When you have financial goals like Child Education, Kids Marriage, Buying a House 2 things are paramount

a.      start early (If you have to accumulate Rs.100,000/- you have to save ~Rs.6200 at 10% returns for 10 years while if the period is 5 years we have to save ~ Rs 16,400 – the amount is ~2.5x vs if you started our early and had 10 years to go

b.    Know the target – Plan in advance and know that you will need 30 lakhs for your child education in next 10 years. It forces you to think over expected returns, how much you need to save and in most cases it will force you to cut down on unwanted expenditure

2)     Core asset allocation is never thought through – I know so many people who put money in FD without even asking themselves whether they have a better investment opportunity both in terms of higher return at same risk or much higher returns at relatively higher risk. I have seen this happen even with Finance Professional which is cardinal in my view

3)     Never consult – Most people never consult experts in these subjects due to utter ignorance or self-ego (I know what is best suited for me)

So what are the investment options available to average individuals

·         Gold – the metal gives very low returns over a long period of time (low single digits). While what you need for weddings etc can be bought its criminal to invest in Gold

·         Real Estate – Buying a house to stay can be still thought through otherwise I don’t think current real estate prices in large cities in India warrant even considering it as an investment. Government in my view will continue to clamp down on the sector to correct the excesses

·         FD – 6-8% return with a tax liability

·         PPF – 8-8.5% with Tax benefit – some proportion of your income should go into this for future savings and a rainy day

·         Equity/MF SIP – could return 15-18% over a long period of 8-10 years. If you want to invest for less than 5 years please stop reading this blog because it’s going to be a waste of time

So how should one plan their asset allocation? In my view at least 35%-50% of your take home (net of taxes) should be saved. In some cases this might be difficult due to certain liabilities but we should aspire for this. Assuming this is Rs.100/- the younger you are the higher the allocation to equities/MF SIP. A good thumb rule which a lot of people advocate is 100 minus your age should be your allocation to equities. However I would suggest people should at least start with 10-15% equities experience the asset class and then increase the allocation as you get more comfortable with it.

Now back to why MF SIP v/s Equity Investing especially for people who don’t do equities full time or for people who don’t have a finance back-ground. Lot of people keep asking me as to stock ideas which they would want to invest in. In equities you need to give time for returns to accrue. We should ideally invest with 5-7 year horizon. Most people want instant karma and treat equity investing as a gambling den where they wish to make 35-40% returns in 3 months. It usually all good till Bull Markets last but it all falls apart when we are hit by a market correction. Another trait if people want to invest money at the top of the bull market because 1) it’s in fashion 2) they feel they can make a quick buck in 15-20 days. In my decade of working experience I have come across a handful of people who have made very good returns across market scenario’s it’s a rarity.

Hence to avoid falling in market traps and to invest money in small instalments MF SIP is a great vehicle especially for people who are not actively into equity markets or not from finance field in general. Over the decade, interacting with hundreds of my friends/colleague in the industry our biggest regret has been buying too much in euphoric markets and buying too little in tough markets which mean our outcomes by and large will be sub-optimal. I still remember when the index halved in Dec 2008 I was shocked when people I used to look upto as equity experts stopped SIP’s or dint invest money in the markets because the fear took over. So through Jan 2006 to Jan 2008 was greed while Jan 2008 to May 2009 was all fear. It’s very difficult to control Human emotions. If the price is Rs.100 and moved to Rs.110 im enticed to buy because it will become Rs.120. However it became Rs.90 I won’t buy because I will wait for Rs.80 /Rs.70 and so on and actually never end up buying and regret when it becomes Rs.150 in 2 years. MF SIP’s are a great way to tackle this Human Emotion as you can invest small sums of money and it will keep averaging itself and create huge wealth over a long period of time. In the above example if this was hypothetically an SIP I would have bought 1 share at Rs.110, one share at Rs.90, one share at Rs.80, one share at Rs.130. My average cost would still have been Rs.102.5 and I would be sitting on 21% annualized return for 2 years

In my view MF SIP will be able to generate 15-18% IRR over a 8-10 year period which means we can beat debt by almost 2x. So my suggestion would be to start with small sums, invest for the long term and have concrete financial goals. It would be unfortunate if I can’t impart my knowledge and help people make money in Equities. India is undergoing a huge transition and there is tonnes and tonnes of money to be made in Equities.

If compounding is the eighth wonder of the world then SIP is the ninth.

I would like to Thank Apeksha Desai, Ajitesh Nair and Abhishek Bhandari for proof reading the blog.

Cheers - HD

PS: I would avoid recommending MF’s on a public forum but anyone who wishes to discuss financial planning with me is most welcome on hiralbdesai@gmail.com or my mobile number

There are more sophisticated/customized ways of investing in equities through Private Equity Funds, AIF’s and PMS for more informed investors. The above article is for my friends who are either not from the field of finance or are not active equity market investors. Even for people like me who are active in equity markets and do this for a living a small allocation to SIP might not be a bad idea.