When we think about long term investing, in the last three to four years the following scenarios seems to be surfacing –

1. Bull run in equity market has resumed since August -2013 and is still continuing.

2. There has been a structurally downward shift in interest rates until now, resulting in returns of longer duration funds and gilt funds marching in tandem with equity market returns. On a flipside, downward shift in interest rates have had a cascading effect on interest rates on bank fixed deposit. The interest rates on bank fixed deposits have fallen as low as 6.5% p.a. to 5.5% p.a. for certain amounts and tenure, resulting in negative real return for FD investors when computed on a post- tax basis.

3. Accelerated fall in real estate market post de-monetization coupled restriction of income tax rebate for interest on home loan upto Rs.2 lac on every house. Investment in real estate in the form of house creating huge wealth for investors is the fact of bygone era.

4. The glitter of gold no more entices investors to own it either in its physical form or through ETF route due to gold price being just flat to negative since last 5 years.

All the above factors have impacted investor psyche significantly leading to a structural shift in the investment pattern and asset class selection of Indians, what we popularly term as financialization of savings. Moreover, there is an increasing awareness amongst investors towards goal oriented financial saving and investments. An investor envisages equity investments as a vehicle to accomplish various goals and dreams in their life. Investors are now increasingly becoming appreciative towards mantaining financial discipline and are more ready to sail through stormy volatility of equity market. They prefer investment in equity market class through SIPs route.

Investors here need lots of help and guidance towards structuring SIPs such as what should be the idea SIP tenure, what type of fund should be selected etc. SIP tenure depends upon investor’s return expectation and a particular financial goal to be accomplished. SIPs are meant for

long term investment so it would be appropriate to select a small cap fund.
Let’s here examine past returns of small cap funds in aggregate.

Exhibit-1 shows generated by small cap funds as a category as on October 31,2017

Exhibit :1

SIP Tenure P2P simple annualized return

3 Year 24.09 %

5 Year 42.71%

10 Year 19.14%

(Source: Value Express)

It would be worthwhile to note that the above are still past returns, its future sustainability is unpredictable. We need to refine our analysis acknowledging past data only for intuitive purpose.

Let us trying to normalise return data of Exhibit-1, include two more SIP investment tenure 15 years and 20 years respectively and exclude 3-year tenure for SIP investment route. This is done based on the fact that investment in equity is meant for longer tenure. Long term here is more than 3 years. Basis this, we may consider the following set of expected return data for a small cap fund.

Exhibit-2

SIP Tenure P2P simple annualized return

5 Year 18 %

10 Year 15%

15 Year 12%

20 Year 12%

We may also hypothetically consider an investment amount of Rs.10,000/- p.m. Let us now, integrate investment amount per month with return data linked to SIP tenure. The result is shown in the following chart.

The above chart shows how beautifully the magic of power of compounding works and total amount invested grows with SIP tenure. As the SIP tenure increases the total amount invested grows more exponentially and in manifold, even though return expectation for a longer tenure SIP is lower.

To sum up, if an investor remains invested for 20 years as compared to 5 years, she can quadruple original investment amount as against around 1.5 times for 5 years. In 20 years Rs.24 lacs invested becomes Rs.99 lacs as opposed to Rs.5 lacs becoming Rs.9 lacs in 5 years, provided return expectation as depicted in Exhibit-2 materialises.

This is how wealth can be created in abundance with discipline, system and passive long-term approach.

-Jayna Gandhi, CFA

Disclaimer : This article is written with the intent of knowledge sharing initiative and not purported to be an investment recommendation.