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Slow but Steady Wins the Race - Outside View by PersonalFN

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Slow but Steady Wins the Race
Jun 25, 2016

Aditya, a 35-year-old entrepreneur, runs a chain of multi-cuisine restaurants in Mumbai. One Friday evening, he saw Rahul, a childhood friend, at his restaurant. They were very happy to meet after many years and relive their childhood memories.

Rahul was amazed to see the way Aditya had built up his business in last 5 years, and was eager to know his financial story.

Aditya shared how he started his financial journey by making small investments in mutual funds through the SIP (Systematic Investment Plan) route. In his mind was a simple plan, in order to achieve all life goals, which were:

  • To open up a chain of restaurants;
  • Buy a dream car;
  • Finance his own wedding; and
  • Live a blissful retired life

Aditya always did thorough research and diversified his portfolio as per his risk appetite. He believed in systematic financial planning, and ignored short term gains.

On the other hand, Rahul, who works as a Vice-President with a reputed investment bank, followed the market trends and invested a large sum of money in the funds that were doing well back in the day. He indulged in momentum playing to make the most of the market movement. But in the name of investing, he was actually speculating!

The short-term gains gave Rahul a winner's high and he earned a good amount of returns. However, as soon as the markets entered into a bear phase, he had to kick himself out of the market. He was over ambitious and is now burdened with a huge amount of debt. He finds it difficult to repay his loan and monthly EMIs.

'Surgical knowledge depends on long practice, not from speculations.' Marcello Malpighi, an Italian physician, physiologist, and biologist has so aptly explained.

But unfortunately many of us get caught up in the rat race indulging in momentum playing, rather than taking the course to become 'classic investors'.

You see, mutual funds powered by a host of advantages can help you build wealth and realise long-term financial goals - much like what Aditya did. But only a handful of people follow the right financial discipline while they aspire to reach new heights.

Mutual fund schemes, as an investment avenue, offer you different modes of investing. The two most common modes are: Lump sum or a One Time Investment and Systematic Investment Plans (SIP).

Lump sum vs. SIP investing

If you have sizeable amount of investible surplus that isn't needed in the short-term, consider investing the lump sum. Only ensure that when you invest, the market is 10-15% down from its last impulse; or that you're in a bear market so as to draw a sufficient safety margin while you invest your hard earned money with an investment objective in mind.

Systematic Investment Plan (SIP), where a fixed amount is invested in a mutual fund scheme(s) regularly - say monthly or quarterly, is efficient when you do not have large investible surplus but vie to achieve the long-term financial goals of life, viz. buying a dream home, a car, children's future, planning a foreign vacation with family, and even your own retirement. A SIP enforces a disciplined approach towards investing, and inculcates regular saving habits that we all probably learnt as children, especially when we had to maintain a piggy bank. Yes, those good old days when our parents gave us pocket money that we deposited in our piggy banks after spending a few. This showed us that at the end of particular tenure, every Paise saved added up to a large amount.

As it's said, "every drop makes a mighty ocean"; SIP just does that. If you follow the right discipline and ensure that you don't miss a SIP instalment, it can help you achieve the financial goals you've envisioned.

Opting for the SIP mode of investing has advantages...

  • Rupee cost averaging:
  • Since you invest a fixed amount at a set frequency - which could be monthly or quarterly - irrespective of the market movements, you actually mitigate the risk over an investment horizon. So when the market falls, you buy more units at lesser price, and conversely, if the market trends higher, lesser units are bought. As you invest at regular intervals, you get an opportunity to invest at different market levels.

    This is called Rupee-Cost Averaging, and in a way helps reduce the average price and potentially translate it into higher returns.

    NAV Date Systematic Investment Plan (SIP) Lump Sum
    NAV Investment Amount No. of Units NAV Investment Amount No. of Units
    02-Jun-2014 371.96 10,000.00 26.88 371.96 240,000.00 645.23
    01-Jul-2014 342.61 10,000.00 29.19 342.61    
    01-Aug-2014 315.02 10,000.00 31.74 315.02    
    01-Sep-2014 300.58 10,000.00 33.27 300.58    
    01-Oct-2014 285.29 10,000.00 35.05 285.29    
    03-Nov-2014 275.85 10,000.00 36.25 275.85    
    01-Dec-2014 262.25 10,000.00 38.13 262.25    
    01-Jan-2015 283.59 10,000.00 35.26 283.59    
    02-Feb-2015 309.00 10,000.00 32.36 309.00    
    02-Mar-2015 335.30 10,000.00 29.82 335.30    
    01-Apr-2015 362.27 10,000.00 27.60 362.27    
    04-May-2015 372.43 10,000.00 26.85 372.43    
    01-Jun-2015 402.53 10,000.00 24.84 402.53    
    01-Jul-2015 419.49 10,000.00 23.84 419.49    
    03-Aug-2015 429.60 10,000.00 23.28 429.60    
    01-Sep-2015 410.49 10,000.00 24.36 410.49    
    01-Oct-2015 422.53 10,000.00 23.67 422.53    
    02-Nov-2015 443.43 10,000.00 22.55 443.43    
    01-Dec-2015 452.27 10,000.00 22.11 452.27    
    01-Jan-2016 455.95 10,000.00 21.93 455.95    
    01-Feb-2016 466.30 10,000.00 21.45 466.30    
    01-Mar-2016 483.59 10,000.00 20.68 483.59    
    01-Apr-2016 499.00 10,000.00 20.04 499.00    
    02-May-2016 524.88 10,000.00 19.05 524.88 240,000.00 645.23
    Present Value   341,285.20 650.22     338,667.33
    Returns   XIRR = 41.36%       CAGR = 18.79%

    Note: The Table if for illustration purpose only
    (Source: PersonalFN Research)

    For instance, Aditya invested Rs 10000 every month starting from June-2014 through SIP in ABC Fund. As the investments were at a regular interval after two years he accumulated approximately 650 units of the fund.

    On the other hand, if he had invested a lump sum amount of Rs 2,40,000 at the same time he would have bought only 645 units. This is how the rupee-cost averaging works.

    It is not necessary that SIPs will outperform the lump sum every time; especially when the market is in a secular uptrend, but this is a steady way for long-term wealth creation.

  • Power of compounding:
  • With SIPs, you imbibe a regular investment habit that can compound your wealth and enable it to grow leaps and bounds.

    Considering the above example, if Aditya had invested 2.4 lakh two years ago, the total value of portfolio would be Rs. 338,667.33.

    However, when he invested every month, the total value of his portfolio as on 2nd May 2016 would be Rs. 341,285.20. This is because he was cumulatively earning on every SIP instalment.

  • No stress about market movements:
  • If you invest through SIP mode, you need not track the market on a daily basis. But we believe, regular monitoring, reviewing, and rebalancing of portfolio should be done if warranted. Studies have consistently highlighted the ability of equities to outperform other asset classes and beat the inflation bug.

Aditya the tortoise; Rahul the hare...

Remember the tortoise and the hare story? One day the swift-footed hare mocked the slow-moving tortoise. This pinched the hard-shelled Tortoise and he challenged the hare to a race. The hare was over confident and decided to rest for a while. While he slept, the tortoise overtook him, and won the race.

Similarly, Aditya won the race steadily by investing regularly. He was disciplined to attain his financial goals. Aditya always made a conscious choice while investing. He made sure he selected winning mutual fund schemes and held them with a long-term investment horizon in mind. Rahul was overconfident and slept on his investments. He did not bother to keep a check on his investments and received a shock after 5 years.

PersonalFN believes that mutual fund investment needs patience. You should not get carried away with the fund's short-term performance. Prudently selecting the right mutual fund schemes is vital in the path to long-term wealth creation.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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