Where you Invest? Stock? real estate? Gold? Bank Fixed deposit or Mutual Fund? Drink Stocks SIP by SIP

Since the beginning of this year, readers have been asking about where they should invest. One question that has been asked the most is, where should the middle class invest its money for the long-term. This is a perfectly valid question given that price to earnings ratio of the stock market are at exceptionally high levels. The BSE Smallcap Index is going at a price to earnings ratio of 118 in January 2018. The BSE Midcap index is going at a price to earnings ratio of 48 in January 2018. Such levels have been seen only in early 2000 and early 2008, and we all know what happened after that. The fi xed deposit interest rates are very low (and even lower, once income tax has been paid on the interest earned). Real estate returns have been negative for a while now, once the cost of maintaining real estate and property taxes are taken into account.   Returns from gold haven't gone anywhere in many years. Also, there is a huge currency risk involved while investing in gold, given that the yellow metal is bought and sold, internationally in dollars. The legal status of investing in bitcoins and other cryptocurrencies in India, is still not very clear. Over and above this, people have fi nally started to fi gure out that investing in insurance is not the best way to go about it. People have also asked me, if they should stop their systematic investment plans (SIPs), given the high valuations in the stock market right now. Given this background, what should an investor do in order to invest money for the long-term? We are at a juncture where this question is exceptionally important. Before I answer this question, I would like to quote something I recently read. As Dan Ariely and Jeff Kreisler write in Dollars and Sense-Money Mishaps and How to Avoid Them: "Experts at Fidelity Investments recently learned that the investors whose portfolios performed the best were those who had completely forgotten that they had investment portfolios at all. That is, the investors who simply left their investments alone - without trying to trade or manage, without getting trapped by tendencies to herd, overemphasize price, be loss averse, overvalue what they earn and fall victim to expectations - did the best. By making a "smart investment" choice, then leaving it alone, they minimized their money mistakes... It should be noted that some successful investors left their investments alone because they died. That suggests that "playing dead" isn't just a good way to avoid bear attacks; it is also a sound investment strategy."

Hence, as the old Hero Honda advertisement went, fill it, shut it, forget it. The question is how do you implement something like this? You cannot forget your fixed deposit investment because it will mature one day. What about gold? The investment cycles of gold are way too long. And gold is more about ensuring that your money does not lose value. Hence, it is never a great bet if you want your money to grow. What about real estate? First and foremost, it involves investing a large amount of money. You can always take on a loan, but that means paying EMIs. Also, there is a constant outflow of money in the form of maintenance charges and property taxes. And more than anything real estate prices have rallied quite a lot in India over the years, without really falling. Bitcoins and other cryptocurrencies currently have no legal standing. And as far as investment plans of insurance companies are concerned, one never really knows what one is getting into. Plus, it is next to impossible to figure out, which are the best investment-insurance plans going around. Also, getting out of a bad insurance-investment plan remains a very costly process and in some cases, time taking as well. So, what does that leave us with, if we want to make an investment and forget about it. What about stocks? If you have ended up buying a bad stock, holding on to it for the long-term, more often than not, is not going to make you rich. If you have bought a good stock, then this strategy might work. But how do you know that the stock you have bought is a good stock in the first place? Do you have the wherewithal to figure this out? And how will you know that the good stock will continue to be a good stock in the days to come? (Of course, you can always subscribe to the stock recommendation services of Equitymaster). But does an average middleclass individual have the time, the knowledge and the inclination, to figure out which are the best stocks to invest in, and then continue doing it, over the years? In my experience, the answer is no. Why do you think so many middleclass Indians continue to buy LIC policies as investment in the first place? They are not even ready to sit and figure out which are the best broad investments for them, forget, which are the best specific stocks to invest in. (Of course, if you are the kind who has the time, the knowledge and the inclination, then concentrated bets on stocks remain the best way to invest for the long-term). In this scenario, what does that leave us with? It leaves us with mutual funds. How do you invest in mutual funds for the long-term? The best and the cliched answer is, systematic investment plans (SIPs) on equity mutual funds. As the headline for this Letter goes, drink stocks SIP by SIP. The question is why do I say that? The fund manager of the mutual fund an investor invests in can screw up majorly and choose the wrong stocks. Yes, that is always possible. Nevertheless, mutual funds have an inbuilt security mechanism. A mutual fund is not allowed to "invest more than 10 per cent of its NAV in the equity shares or equity related instruments of any company," as per Securities and Exchange Board of India (SEBI) regulations. Hence, equity mutual funds are diversified. So, by this definition, an equity mutual fund should have investments in at least 10 stocks. Given this, even if an investor ends up in a wrong mutual fund, chances are his losses will be limited in comparison to a situation where an investor ends up in a wrong stock. Also, most mutual funds typically tend to have 20 stocks or more. Hence, this essentially limits losses during the period the stock market falls. Over and above this, an SIP essentially helps investors follow the averaging strategy. Given that, the same amount of money gets invested month on month, it leads to more units of the mutual fund being bought when the markets are falling and less units being bought when the markets are going up. It is possible to do this with stocks as well, but psychologically it is very difficult to buy stocks when the stock prices are falling. Most investors do not have the emotional and mental maturity required to do so. In comparison, the SIP gets executed on its own, as long as we don't fiddle around with it, and try to time the market. So, over a period of time, because SIPs force investors to buy more units when markets are falling, they tend to give decent returns. Given this, the answer to the question, whether investors should stop their SIPs now, the answer is no. The entire idea behind investing through this route is to ensure that you don't have to time the market because believe me nobody other than George Soros has any idea about this. As I keep saying, the market can remain irrational longer than you can remain solvent. And let's say a huge thank you to John Maynard Keynes, for saying this. Also, given the low level of mental involvement required to invest through the SIP route, it remains the best form of investing for individuals looking to invest over the long-term. Now all this is basically theory that has been written about times over the years. So, let's look at some data on mutual funds and SIP returns, over different time periods. Whenever a case is being made for investing in mutual funds through the SIP route, typically, the SIP returns of best performing mutual funds tend to be shared. Along with sharing the SIP returns of top 5 funds, I will also be sharing the SIP returns of the worst 5 funds. And that is where it gets interesting. The SIP returns have been provided for Morningstar India (www.morningstar.in). Now let's start with the SIP returns of the best and the worst funds (Table 1 and Table 2) in the large cap category over a period of five years. These are funds which invest in large cap stocks. Table 1: Best performing large cap funds through the SIP route over a five-year period.   Per year returns (in oer cent) Mirae Asset India Opportunities 22.70 JM Core 11 22.49 Kotak Select Focus 22.00 JM Multi Startegy 21.60 Reliance Vision 21.28 Source: Morningstar India.   Table 2: Worst performing large cap funds through the SIP route over a five-year period.   Per year returns (in oer cent) JM Equity 12.46 LIC MF Equity 13.00 HDFC Large Cap 13.05 Taurus Bonanza 13.46 LIC MF Growth 13.88 Source: Morningstar India. What do Table 1 and Table 2 tell us? The difference between the returns of the best funds and the worst funds is substantial. Nevertheless, even the worst funds have given better returns than the interest an investor would have earned on fixed deposits, the returns on gold and real estate, and the returns on endowment and other traditional investment policies offered by insurance companies. It also beats the returns that different kinds of post office savings deposits give. (Of course, if you had invested in bitcoins during the period, you have probably retired by now. But how many people had heard about bitcoins five years back or even five months back, for that matter). But the good returns on SIPs are also because of the stock market rallying since November 2016. The investors essentially benefitted here because of all the units that they accumulated (even in the worst mutual funds) through the SIP route before November 2016. This logic holds for other kinds of mutual funds as well. Let's take a look at small and midcap mutual funds. These are mutual funds which basically invest in small and midcap stocks. Take a look at Table 3 and Table 4. Table 3: Best performing small and midcap funds through the SIP route over a five-year period.   Per year returns (in oer cent) Reliance Small Cap 39.29 Mirae Asset Emerging Bluechip 33.81 Sundaram Smile 33.05 L&T Midcap 32.77 Aditya BSL Small & Midcap 32.73 Source: Morningstar India.   Table 4: Worst performing small and midcap funds through the SIP route over a five-year period.   Per year returns (in oer cent) Baroda Pioneer Mid-cap 13.36 Axis Midcap 22.31 SBI Emerging Businesses 22.88 SBI Magnum Global 23.42 Invesco India Mid Cap 26.12 Source: Morningstar India. Table 3 and Table 4, tell us that even the worst performing small and midcap funds through the SIP route have done very well, over the past fi ve years. The conclusions drawn up until now, also apply to other kinds of equity mutual funds like fl exicap funds (which can invest in any stock irrespective of their market capitalisation) and tax saving funds (this is true across all time periods that we shall consider here). The trouble is that this is point to point data for the last fi ve years. In order to take care of this weakness, let's increase the time period under consideration to 10 years and then look at SIP returns. Take a look at Table 5 and Table 6 (on the next page), which basically list out the best performing and worst performing large cap funds through the SIP route, over the last 10 years. It can be seen clearly from Table 5 and Table 6 that MF schemes over the last 10 years have given decent returns through the SIP route. Even the worst performing schemes have given double digital after-tax returns (remember there is no long-term capital gains tax on equity mutual funds). Table 5: Best performing large cap funds through the SIP route over a ten-year period.   Per year returns (in oer cent) HDFC Equity 17.23 Invesco India Growth 16.74 Aditya BSL Frontline Equity 16.67 Reliance Top 200 16.66 SBI Blue Chip Fund 16.65 Source: Morningstar India.   Table 6: Worst performing large cap funds through the SIP route over a ten-year period.   Per year returns (in oer cent) JM Equity 10.18 Taurus Bonanza 10.91 LIC MF Equity 11.02 HDFC Large Cap 11.35 Sundaram Select Focus 11.68 Source: Morningstar India. While, property returns may have been greater over this period, but you need to take into account the fact that investing in property needs a bulk payment and comes with many other risks, including the builder delaying deliveries and sometimes even disappearing with the money. SIPs on the other hand involve a monthly payment (of course nothing works like property if you have some black money to invest). Now, let's also take a look at the 10-year SIP returns of small and midcap funds in Tables 7 and 8 (Table 8 is on the next page). Table 7: Best performing small and midcap funds through the SIP route over a 10-year period.   Per year returns (in oer cent) Canara Robeco Emerging Equities 24.46 Franklin India Smaller Companies 26.00 HDFC Mid-Cap Opportunities 24.61 L&T MidCap 24.40 Edelwiess Mid & Small Cap Fund 23.83 Source: Morningstar India.   Table 8: Worst performing small and midcap funds through the SIP route over a 10-year period.   Per year returns (in oer cent) HSBC Midcap Equity 20.76 Aditya BSL Mid Cap 26.00 ICICI Pru Mid Cap 21.20 SBI Magnum Global 21.24 Reliance Mid & Small Cap 21.32 Source: Morningstar India. Tables 7 and 8, show us very clearly that even the worst-performing small and midcap funds have done very well, over a period of ten years, through the SIP route. This essentially proves the long-term eff ectiveness of investing through SIPs. A 20 per cent return, year on year, over a period of twenty years, is a fantastic rate of return. An investment of Rs 5,000 per month, for a period of 10 years, at the rate of return of 20 per cent per year, would have accumulated to around Rs 19.1 lakh, which is clearly a lot of money, given that in total, Rs 6 lakh would have been invested during the period. And this money wouldn't have been invested at one go, but Rs 5,000 at a time. Some real wealth would have been created. Now let's take a look at 13-year SIP returns. This, for the specifi c reason that around 2005, the mutual funds actually got around to promoting the idea of an SIP to investors. Up until then, it was merely a theoretical concept, which most investors hadn't even heard about. Let's start with Table 9 and Table 10, and look at SIP returns of best and worst large cap funds over a period of 13 years. Table 9: Best performing large cap funds through the SIP route over a 13-year period.   Per year returns (in oer cent) HDFC Equity 16.75 Aditya BSL Frontline Equity 16.57 HDFC Top 200 16.65 HDFC Growth 15.05 ICICI Pru Top 100 15.01 Source: Morningstar India.   Table 10: Worst performing large cap funds through the SIP route over a 13-year period.   Per year returns (in oer cent) JM Equity 8.65 Taurus Bonanza 9.77 LIC MF Equity 10.04 HDFC Large Cap 10.46 LIC MF Growth 10.87 Source: Morningstar India. As far as worst funds are concerned, chances are that the returns from the public provident fund (PPF) would have been similar to the returns from JM Equity Fund, over the 13-year period. But the other worst performing funds, have more or less given, double digit, after tax returns, which is pretty decent and better than other financial forms of investing. Now let's take a look at Table 11 and 12 (on the next page), which list the best and the worst SIP returns of small and midcap funds, over a 13-year period. In this case, given the fact that there weren't many small and midcap funds operating 13 years back, the tables have listed only the best four and the worst four funds. Table 11: Best performing small and midcap funds through the SIP route over a thirteen-year period.   Per year returns (in oer cent) Sundaram Sel Midcap 21.49 L&T Midcap 20.88 UTI Mid Cap 19.88 Franklin India Prima Fund 19.55 Source: Morningstar India.   Table 12: Worst performing small and midcap funds through the SIP route over a thirteen-year period.   Per year returns (in oer cent) ICICI Pru Midcap 17.90 SBI Emerging Businesses 18.64 Tata Mid Cap Growth 18.79 Aditya BSL Mid Cap 19.11 Source: Morningstar India. Given the small sample size, the 13-year SIP returns of the worst performing funds and the best performing funds, aren't really that different. If you had an SIP of Rs 5,000 going over the years, and that SIP produced a return of 18 per cent per year, how much would that amount to by now? Rs 31.13 lakh, from a total investment of Rs 7.8 lakh, spread over a period of 13 years. Not a bad going at all. To conclude, SIPs may not be the best way to invest, if you have the time, knowledge and inclination to invest in stocks. It may also not be the always the best way to invest, if you have the wherewithal and the capital to buy property at knocked down prices or be an early stage investor in them, and then ensure that deliveries are made more or less on time, and the builder does not take years to complete the project, or simply disappears with your money. But SIPs are the most optimal way to invest if you do not have the time, the inclination or the knowledge to figure out what is the best investment going around. All it needs is a regular check-up of around once a year, of how the mutual funds are doing and if some mutual fund is doing particularly badly over a longish period of time, then a decision needs to be made. Also, it makes sense to spread your SIP over four or five mutual funds, from different asset management companies.