Here is the historical data of returns NIFTY has given over the last 2 decades. (Reference)
It is easy to get lost in this noise. Even worse, many try to derive the correlations of the data to events, or seek elusive micro-patterns and try to time the market in the short term to maximize gains. Recently some Financial Influencers on YouTube commented that Govt ensures that the stock market goes up before the election year. That is far from the truth. If you see the run-up to both the last 2 general elections in 2014 and 2019 which happened in April, NIFTY underperformed in 2013 (6.76%) and 2018 (3.15%)! I’m not an expert in technical analysis indicators either, but all I have observed is that all of them are trailing indicators, and bring in probabilistic output. So if probabilistic data is what governs the decision, why not simply it for common retail investors to make them get a better return on investment (ROI) of one’s time and money? I measure ROI in both the Time and Money axis. We often ignore the time put into monitoring your portfolio and decision-making.
Tool
To support my simplified investing strategy further down, first, it is important to understand the concept of rolling returns of mutual funds. Rolling returns shows a picture of how a fund has performed within a window of duration t, starting from T to T+t. Moving this starting point of investment T will then give a sliding window performance picture of various intervals in past. I found this tool in advisorkhoj which helps you quickly visualize this data. Here is the reference data on rolling returns based on which I will base my observation and recommendations.
Analysis
The above chart shows a rolling window of 5 years for data since 1999. To put it in another way, how much would my money have grown to in the 6th year at various points in history? In that time range, you can see the Return distribution (% of times) it has delivered in different profit% ranges. For example, the fund has given gains of between 12-15% for 24.40% of the time since 1999 for a 5-year investment.
Observation 1 – The probability of negative returns comes down to 0.11% for 5 years rolling window! And that too, are the time intervals where something significant happened (such as the 2008 subprime crisis or the 2020 Covid disaster). Obviously, the rule of investing is not to panic sell in those moments. So if you do not panic sell, and even hold on for another few months, there is almost a guarantee of never losing out on principal (this is just for pessimistic investors!).
Observation 2 – As and when you increase the rolling window duration, you see more stability (read: probability) in high % returns. Here are snapshots of rolling windows of 2, 5, and 7 years duration.
Focus on the right side of the table first. What do you observe? As the investing timeline grows, your probability of higher returns goes up. Take a look at the 12-15% and 15-20% columns. For the 7-year window, the Negative return is zero!
You might argue the obvious now. Hey! A 2-year window has given > 20% return 36.76% of the time. Isn’t that a great deal? Hold on a bit. Let’s move now to the left table which gives a picture of the variance (or in other words, the volatility). The minimum return over 2 years has at times gone as low as -20.99%, whereas it has always stayed positive for a 7-year window.
In a brutal equity market, what one should optimize for is not losing money EVER. Instead, most retail investors look at maximizing profits.
Strategy
So all this data, yada yada statistics! What strategy can I employ then? Here are some directions. This may not be the only one, but the direction aligns with the data and the Rules of investing I just outlined above.
● Do your own investing SIP (Systematic Investment Plan) on Index Funds i.e. invest a lump sum each quarter. I say quarter and not month so that it’s easy to manage your withdrawal. You can also think of a semi-annual SIP, but I would go for quarterly just so that I don’t miss out on buying opportunities in some dips. Continue this forever!
● At the end of 5 years or close to that, T+5 +/- a few months, you will have generated enough compounded profits on around the 8-15% returns range. Book the profit for that T-5 year SIP, and re-invest the principal again. You only need to pay LTCG tax at 10%
The question you may ask is if the appreciation hits 15% before 5 years, should I book profits? My opinion is, NO. You need to give time for compounding too. A single-year 15% return isn’t good compared to a 4-year compounding 10% return. So patience and some basic mathematics will help you decide here.
Advantages
There are other advantages of going via the Index Fund route. The expense ratio on Index Funds is the lowest i.e. in the range of 0.15 – 0.20 % compared to as high as 1-1.5% for other actively managed funds. For those who underestimate the expense ratio, it does make a big dent in your final returns. The expense ratio is something the MF manager pockets irrespective of your fund appreciating or depreciating! So be aware of this parameter, even while choosing amongst different funds. You can also consider Index ETF funds which have an even lesser expense ratio of around 0.05%, but there are pros and cons to buying ETFs. Here is an article that explains the differences.
Selection Options
If you want to analyze some specific Index Mutual Funds, here are a few sources –
● Motilal Oswal Nifty 50 Index Fund
● ICICI Prudential Nifty 50 Index Fund
● SBI Nifty Index Fund
There isn’t much to choose between each of them. All of them are fundamentally invested on the same benchmark. Just look out for any variation in expense ratios. Do go with the Direct Plan investing i.e. directly setup your portfolio from the Mutual Fund House (Regular Plans attract additional charges).
Should we invest in NIFTY 50 index or BSE Sensex index such as ICICI Prudential S&P BSE Sensex Index fund? My personal preference is the Nifty 50 because of more diversification (Sensex constitutes the 30 strong companies in terms of market capitalization). Here is a 7-year Rolling Returns chart for BSE Sensex Index. I found the Nifty50 more promising. This could be due to the more diversified portfolio in NIFTY, but I do not have exact data to back it up.
Wrap up
I believe that Index Fund investing is one of the best strategies that should be part of your diversified portfolio primarily based on the reasonable returns you get against your time and mental energy. It is an excellent form of investment for generating stable recurring income for your midterm goals. And when I say midterm, 5-7 years is a sweet spot. Beyond that, there could be some sort of diminishing returns that will creep in. And after all, you are investing for a purpose, not just for the sake of keeping your money invested forever!
Make the money work for you; don’t work to make money.
