The message that comes across over the 10-year horizon is that trailing returns of large-cap funds (12.36 per cent) were better than that of broad market benchmarks like the Nifty or the Sensex. Returns for gold (standard gold Mumbai) were slightly higher (12.84 per cent) than the average for the large-cap category. Public Provident Fund (PPF) returns have been lower at 8.32 per cent compound annually over the past decade.
Fixed deposit rates, if you use the SBI one-year term deposit as our benchmark, have ranged between six per cent and 10 per cent over the past decade (though some other banks may have offered slightly higher interest rates). Trailing returns of other categories of diversified equity funds like multi-cap (13.55 per cent), mid-cap (15.63 per cent) and small-cap funds (14.39 per cent) were higher than that of the large-cap category over the 10-year horizon
If you had a 40 per cent allocation to large-caps, 30 per cent to multi-cap, 20 per cent to mid-cap and 10 per cent to small-cap funds, your weighted average return over the 10-year period would have been 13.57 per cent, better than that of gold and fixed-income instruments. Over the three- and five-year horizons, equity mutual funds trounced the market benchmarks (Sensex and Nifty) and gold, PPF, and fixed deposits quite easily. It is only over the one-year horizon that the trailing return (the rate you earn when you invest a lump sum amount) of diversified equity funds (barring small-cap) lag that of gold and fixed income products.
SIP trumps lump sum
Our number crunching over 10 years also demonstrated unambiguously that Systematic Investment Plan (SIP) investing is a much better way to ride diversified equity funds than lump sum investing. Only over the three-year horizon have SIPs underperformed lump sum investments. This was a period when the markets rose around 40 per cent, and SIPs tend to underperform in such rising markets. Over most other investments, SIP investments have trumped lump sum investment. Experts attribute the better returns from SIP investing to high volatility. Says Vinit Sambre, vice-president and fund manager, Since the financial crisis of 2008, the equity markets have witnessed many bouts of volatility. This volatility, which affects equity investors and causes them agony, has proved a boon over the longer term for those who have used the SIP route. Those who don’t stop their SIPs when markets decline are usually rewarded with handsome returns over the long term.
Another fact that the comparison of trailing and SIP returns throws up is that more volatile fund categories like mid-cap and small-cap funds benefit more from SIP investing. Over most investment horizons, SIP returns of mid- and small-cap funds have been higher than their trailing returns. Being volatile in nature, these funds fall sharply, allowing SIP investors to average down their cost of purchase.
Don’t ignore lump sum completely
Investing through SIPs does not mean that investors should avoid the lump sum route entirely. When the markets fall steeply, savvy investors can take advantage by putting in additional lump sum in the same funds in which they invest via SIPs. Also remember while mid-cap and small-cap categories have given higher returns in the past, they are very volatile. Investors should have only a limited exposure of 20-30 per cent of their equity portfolio to these funds.
Investors should avoid making lump sum investments over a short to medium-term horizon of three-five years. However, do not jettison a fund in haste. Don’t redeem a fund if there is short-term underperformance. Markets and fund managers both tend to go through lean phases. But, if a fund lags its benchmark or category average consistently over a year or more, get rid of it.
Diversify the portfolio
To reduce volatility, have a mix of equity and debt funds in most portfolios. PPF offers an interest rate of 8.1 per cent. Returns from PPF are tax-free and you also enjoy the benefit of Section 80C tax deduction. PPF is suited for investors who have a long investment horizon and low need for intermediate liquidity. Its interest rate is, however, subject to revision every quarter (unlike in the NSC, where it is fixed).
Another favourite of conservative investors is the bank fixed deposit. While fixed deposits are simple, safe and liquid, interest rates on them have been declining. Five years ago, you could have earned 9.55-10.50 per cent on the one-year deposit; today, this rate has come down to around 7.25-8 per cent. Investors relying on them run the reinvestment risk: When your FD matures, you may have to reinvest it at a lower rate. FDs are also tax-inefficient for those in the highest tax bracket. Finally, gold acts as a good portfolio diversifier since it has low or negative correlation with equities. But, it tends to be volatile. Limit your investment in it to eight to 10 per cent. By investing in sovereign gold bonds, you can earn 2.75 per cent on your initial investment.
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