Don’t try to time the markets. Invest in Mutual Funds and sit tight for long term and you are guaranteed to make high double-digit returns.
Pretty sure you would have heard (or read) this advice multiple times. But have you ever gone back and tested it out? Does this theory hold true?
We will try to answer the exact same question. But, unlike folk wisdom, we will use data to make conclusions.
We will show that getting the timing right does have a significant impact on your returns – even for periods as long as 10 years.
“But let’s not dismiss the above statement completely. There is some truth to it. If you hold for long enough tenure, you are pretty much certain to clock better-than-FD returns. However, the impact of timing on overall returns is still very significant, as we will see shortly.
But before we look at the numbers, let’s just quickly introduce the concept of Price-to-Earnings ratio (P/E). PE is one of the most widely used metric to gauge market valuations (if the market is expensive or inexpensive or fairly valued). You can read up more about P/E ratio here. In this article, we will use the P/E levels of Nifty 50 index derived by dividing the Nifty value by the profit of it’s underlying stocks (on a per share basis).
There are number of ways to calculate P/E ratios. Note that “P” is the current market price. But “E” can be interpreted differently. You can use 1-year forward EPS or 1 year trailing EPS. For the purpose of this analysis, we will use the official PE numbers published by NSE here.
P/E is just one of many valuation parameters. There are many more. But again, for the purpose of this analysis, we will just use P/E.
So what do the numbers say?
What we will do is see how your returns would have turned out if you would have invested in NIFTY 50 index at different PE levels.
We will look at 1-year, 3-year, 5-year and 10-year returns. Let’s look at the table below:
The data is compiled by using all trading days of NIFTY for last 20 years. The way to understand this table is as follows:
The left most column denotes the PE band. Each band gives you the result for all days (since Jan 2001) on which NIFTY PE was in that particular band.
Suppose you invested in NIFTY index on all days when PE was greater than 24 and held for 5 years. Then your average return would have been 2.5%. Also, there was an instance when you would have ended with a negative 1% return (worst case).
Similarly, suppose you invested at times when PE was between 14 to 17 and held on for 10 years, then on an average, your returns would have been 16.1% and the worst-case instance would have been 9.6%.
Now that we understand the table, let’s analyze the result. As you can see, as you move down the rows in the table, your return numbers (both average and minimum) keep getting worse. What does this mean?
Simple….if you enter the markets at higher PE levels, you are likely to end up with lower returns. And this is applicable for all holding periods. Just imagine this – if you invest in NIFTY at PE levels higher than 24, even for a holding period as long as 10 years, on average you would earn just 6.1%. That even worse than FD returns!
Another interesting thing to note is that as your holding period increases, the impact of timing reduces. Nonetheless, impact remains and is pretty significant.
Moral of the story is that timing your entry matters and matters significantly. And yes, even for long term.
But does this hold true even for an actively managed fund?
The above numbers are basically NIFTY returns – based on the assumption that the investment was made into NIFTY 50 index. What if you invest in an actively managed Mutual Fund? Does the above theory still hold true?
Not surprisingly, it does.
Below is a similar table as the table shown above. However, these are return numbers for a top-performing multi-cap fund called ICICI Prudential Value Discovery.
As it turns out, what was true for NIFTY is also true for ICICI Value Discovery.
Well, in the end, it’s pretty simple – the impact on your returns as you move from lower PE entry to a higher PE entry is simply too large to ignore.
…and btw, the NIFTY PE is already 28.23
Look at the chart below
Last time we saw these PE levels was way back in Jan 2008. And we all know what happened after that – a 60% crash in a matter of 14 months!
We have already seen that making investment into equity mutual funds at times of low market (NIFTY) PE yields significantly higher returns in the long term.
Given this knowledge, what should you, as an investor, do now that the PE is already hovering around it’s all time high?
Should you hold on to cash and wait for markets to correct? Say markets correct by 15% in next 3 months. Then what? Should you go all in or wait for further correction?
The truth is that no can perfectly time the market. No one has ever done it and no will ever be able to do it. However, what can be done is to use historical knowledge (data) and train a machine (computer) to make investment choices that maximizes the chances of earning high returns.
And that is exactly what we do at Finpeg. Using data from last 20 years, we have built intelligent investing algorithms geared towards maximizing returns and minimizing risk.
Do visit our website and if you like what you see, please do get in touch!