Financial history tells us that stocks out-perform all other asset classes in the long run. Rs. 10000 invested in BSE sensex stocks in1979 (BSE Sensex, which was 100 in 1979, is around 39000 in July 2019) would have a market value of around Rs 39 lakhs today, excluding dividends. On the other hand, Rs 10000 deposited in a bank fixed deposit in 1979 would be worth around Rs 3.2 lakhs now.
Why mutual funds?
Even though stocks out-perform all other asset classes by a wide margin, very few people have the time and expertise to invest in the stock market directly. Therefore, a very good option for investors is to invest in stocks through the mutual fund route.
What are mutual funds?
Mutual funds mobilize the savings of investors who share a common financial goal. Professional fund managers invest this money in securities like stocks, bonds, debentures etc. in line with the fund’s investment strategy and the investment objective of investors.
Mutual fund investment can be done either in lump sum or in installments. SIP (Systematic Investment Plan) is an ideal form of investment where the investors invest at regular intervals, say, weekly, monthly or quarterly. Monthly SIP is an ideal strategy. Since the investment is done systematically the investor gets the benefit of Rupee Cost Averaging. This means that since investment is done regularly, the investor gets more units when the prices are down, thereby reducing the average cost.
During the last 40 years, in India, bank fixed deposits have yielded around 9 % annual return; return from gold has been around 10 % while returns from stocks (as measured by the Sensex) has been around 16 %. Clearly, stocks have out-performed bank deposits and gold by a wide margin. Mutual funds, particularly SIPs, have out-performed the index.
Choosing the right kind of funds
Choosing the right mutual fund is not easy. This requires some expertise. Return from mutual funds can vary from fund to fund and across schemes. For instance, if we take the performance of equity fund SIPs in the last 20 years (from June 1999 to July 2019), we can see wide divergence in performance. The best fund has delivered a CAGR of 21.12 %; the worst performing fund delivered only 9.62 % CAGR and the average fund performance was 15.98 % CAGR. The best Multicap fund delivered 20.22% while the worst Multicap fund delivered only10.18%. The best large-cap fund delivered 19.62%, while the worst large-cap fund delivered only 10.63%. Therefore, choosing the fund and the scheme becomes crucial. Here, investors should do their own due diligence, if they have expertise in the area, or take the advice of experts.
It is important to appreciate the fact that during the 20-year period June 1999 to July 2019 the worst performing equity SIP scheme delivered an annualized CAGR of 9.62 %, which is much superior to the returns from bank FDs during this period.
Importance of staying invested
To reap the benefits from SIPs it is important to stay invested for a long period of time. Unfortunately, most investors do not show the patience to remain invested for long. Typically, most retail investors jump into investment at market peaks; and panic and exit when the market corrects sharply. This is the exact opposite of an ideal investment strategy. Big money is made on investments done during sharp corrections. It is difficult, almost impossible, to correctly call the market peaks and bottoms. The only sensible strategy is to stay invested for as long as possible.
The tax advantage
A major attraction of investment in stocks and mutual funds is the tax advantage. Dividends from stocks are exempt from tax up to Rs 10 lakhs a year. Dividends from equity mutual funds and hybrid funds are taxed only at 10 %. Another major attraction of investment in stocks and equity/hybrid mutual funds is the favorable tax treatment of LTCGs (Long-Term Capital Gains). Long-term capital gains are the gains accruing to investors when they sell stocks/equity/hybrid funds at a profit after holding them for a minimum period of one year. LTCGs up to Rs 1 lakh a year are exempt from tax and LTCGs above Rs 1 lakh are taxed at only 10 percent. If the investment is done under ELSS, investors get 80 C tax exemption too. This makes the returns from MFs extremely attractive.
Put some eggs in the strongest basket
Conventional wisdom forbids us from putting all eggs in one basket. Therefore, it is desirable to have a good variety of assets in your portfolio. However, it is important that an investor has the best-performing asset class – equity/ mutual funds – in his/her portfolio. So, invest a part of your investable funds in mutual funds, ideally through the SIP route. Select a good fund and ideal scheme that suits your risk appetite and help you in realizing your financial goals. There are more than 40 AMCs and thousands of schemes to choose from. Choose good AMCs with a good track record and the schemes that suit your investment objectives. Geojit Fund recommendations are available in Geojit Insights magazine.
Investment in mutual funds through SIPs is the best strategy to participate in the India Growth Story.
Updated: July 2019