You must invest for 10 years or more to enjoy compounding benefits

The volatility witnessed in the equity market in recent months has taken a toll on equity funds as well, going by tapering investor interest in these schemes.

The equity market, as represented by S&P BSE Sensex and Nifty 50, was down nearly 13% and 22% for the six-month and one-year periods ended February 29, respectively, on concern over growth of the global economy and delays in reforms. As if on cue, equity funds have seen a sharp decline in inflows – to Rs 2,500 crore in February, down from a 21-month average of Rs 6,900 crore.

This shows investors have panicked, and started pulling out at a time when they should be investing more instead. One gets to buy more units of a mutual fund when the net asset value (NAV) of its units declines because of some erosion in the value of the underlying asset.

Look beyond volatility

To be sure, volatility is inherent in equities as an asset class and short-term fluctuations are par for the course. However, in the long term, equity is as good a wealth-builder as any.
For the record, since its inception in 1979, the S&P BSE Sensex has given CAGR (compound annual growth rate) returns of 17% and 15% in 10- and 15-year rolling periods, respectively. This has had a rub-off on equity funds, too. For instance, between February 2000 and February 2016, the index returned at a CAGR of 9.4%. During this period, an investment in equity mutual funds, represented by CRISIL-AMFI Equity Fund Performance Index, would have delivered a CAGR of 13%.

SIP it slow, and long

One good way of dealing with the volatility is through systematic investment plans (SIPs), which obviate the need to time the market. By investing at regular intervals, investors benefit from rupee cost averaging – buy more units during a downturn (bear phase) and fewer units in an upturn (bull). Monthly SIP in equity mutual funds – represented by Crisil-Amfi Equity Fund Performance Index – has returned 10% each over seven and ten years ended February 29, 2016.

Case study

An individual starts investing Rs 1,000 in a mutual fund (represented by Crisil-Amfi Equity Fund Performance Index) from April 1997 via the SIP route.

Let's consider three scenarios (See table):

Investor continues to invest Rs 1,000 during bear phases.

Investor doubles his investments to Rs 2,000 whenever the NAV fell more than 10% in a one-month period and reverted to the original investment amount (Rs 1,000) when the NAV surpassed the level before it fell 10%.

Investor stops his investments whenever NAV fell more than 10% in a one-month period and started investing when the NAV surpassed the level before it fell 10%.

The writer is director - funds and fixed income research, Crisil Ltd