One good thing about writing the blog is that I get to interact with different kinds of people. Some are new and keen to learn, others have been investing for some time and are looking for specific inputs, yet others are more interested in challenging what I have to say. I am pretty ok with the last as it gives me a good chance to increase my own knowledge. One of the aspects that I have debated with many people is on the nature of equity returns and it worries me that most people still do not get it in entirety.
To illustrate the point let me ask you this – if you have been investing in equity through Mutual fund SIP route for the last 5 – 7 years, what would be your XIRR today on those investments? Given the levels the markets reached yesterday, it is a fair bet that for most funds the XIRR over the whole period would not be in double digits. However, only about 2 months back when things were looking infinitely more positive, the talk would have been about 15% XIRR and putting all money into equity etc. It may be a scary exercise but check out how your portfolio value has fallen over the last few weeks itself. Of course, most advisers will tell you to continue your investments and say that it will recover its value over time.
The simple truth is no one can predict the markets in the medium term and the long term can be really long. If you have started your SIP in the halcyon days of May 2014 when the government change was there, it may take a fair bit of time for your portfolio to get out of the negative XIRR zone. This is not to say that we should stop doing SIP, in fact quite the contrary as SIP really works well in exactly the type of market we are having today. What matters though is that we take care to understand the illusive nature of equity CAGR and plan things accordingly.
One of the simple things to understand is what kind of returns should we estimate from equity investments when we are making a financial plan and investing for our goals? I have always felt that 12% is probably the magic figure irrespective of what the markets are indicating currently. A higher figure is possible but difficult to sustain and at a lower figure you will need to invest huge amounts for your goals. The other thing to understand is that this money may really not be available when your goal is at hand. Suppose you wanted to but a car costing 12 lacs today and have been doing a SIP for the last 5 years. Today when your goal time frame is reached, your SIP value does not match up to this figure.
The so called experts will tell you that you could invest in debt for a 5 year goal, or that you could redeem equity and transfer to debt 3 years before your goal etc. With due respect to all and certainly no malice, I really feel these suggestions are not worth the paper they are written on. Due to the illusive nature of equity returns it is really impossible to time these strategies and if you are trying to do this, it is really as bad as timing the markets. So what should you be doing then?
We need to embrace the uncertainty of equity returns by doing these few things:-
- Bank on equity only for a goal if we are prepared to be flexible on it. So in the car example, your goal should be ” I want to buy a car in 5-7 years time and will invest 10000 per month assuming a return of 12%”. Aim for your goal in 5 years but be prepared to wait longer if need be.
- Most of your goals may not have such in built flexibility. In such cases you can over estimate your goal amount, see to it as to how your goal can be met through debt investments you have or consider mobilizing money through short term loans etc.
- If you have one time money available for something that you plan to spend in the future, consider doing it today. Let us say you want to go on a family vacation in 5 years that will cost you 6 lacs. Now you can do a SIP for that with an associated risk that things may not work out when the time comes, or you can put 3-4 lacs in debt and hope it will grow sufficiently in 5 years to get close to the amount. A much better way will be to stretch yourself financially, go and enjoy the vacation today with some flexibility and then keep investing for your other goals.
I hope most of you got the point of the post and would be glad to have feedback. In the next post, I will talk of a specific example of children’s education as a case study and show how we can manage things better.
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