Equity Mutual Funds

Why should you invest in equity oriented mutual funds?

This is the first of a two part series. In this first part, we’ll examine how high performing Equity Oriented Mutual Funds have given eye-popping returns (at times in excess of 20% annually) over very extended timeframes, making them arguably the best suited instrument for long term wealth creation for retail investors.

In the second part, we’ll examine how today’s best performing funds aren’t necessarily going to be so forever, and hence why the only way to sustain the superlative returns that equity mutual funds are known to generate is by investing in them through platforms that support automated rule based investing, monitoring and rebalancing of your portfolio – something that’s impossible to achieve through human-driven manual monitoring.

By Indranil Guha

 

Last year I came across this very interesting piece in Economic Times titled “Five mutual fund schemes which have returned an average of 20% every year”. You can access the piece here. The piece contained ET’s pick of five high performing equity oriented mutual funds that have generated returns in excess of 20% annually over the last 20 years.

Now any seasoned investor would tell you that these are astronomical numbers. While equity oriented mutual funds routinely generate 20%+ annual returns during bull runs in equity market, such returns rarely sustain for periods longer than 2-4 years. So 20%+ annual return over a timeframe as extended as 20 years is extraordinary by any standard.

Let’s take a closer look at these funds. The following table illustrates the impact these five funds could have had on your investments, had you invested Rs. 1,000 per month in each of these five funds over the last 20 years (between Jul 1996 and Jun 2016).

 HDFC Equity FundFranklin India
Bluechip Fund
Franklin India
Prima Fund
Birla Sun Life Advantage Fund Reliance Growth Fund
Fund categoryMulti CapLarge CapMid CapMulti CapMid Cap
Amount
invested (Rs)
2,40,0002,40,0002,40,0002,40,0002,40,000
Present value of investment (Rs)39,31,400 31,57,530 45,82,380 18,98,252 45,73,650
Growth 16 times13 times19 times8 times19 times
Annual
Return - (IRR)
23.6%21.9%24.8%17.9%24.8%

Over these 240 months, you would have invested Rs. 2,40,000 in each of these funds. As you can see above, these five funds would have grown your money between 8 and 19 times over the last 20 years. In terms of returns, you could have realised annualized returns ranging from 18% to 25%. These are staggering returns, which far exceed the returns generated by for popular fixed income instruments such as bank deposits. And as if it were not already a great deal, these superlative returns would have been completely tax free, unlike bank fixed deposits, where the entire interest earned is added to the investor’s taxable income of the year.

Now one might argue that these five mutual funds may be outliers, and that all equity oriented mutual funds are arguably not going to generate such high returns. Indeed there’s some merit in this argument. However, you don’t need your investments to necessarily grow at such staggering rates, because very high returns also often means that you are arguably taking on very high risks too. That’s the reason qualified financial planners in India typically assume returns of no more than 13 – 14% from equity oriented mutual funds over the long term, and empirical data suggests funds that have generated returns in excess of 13% annually over long periods aren’t necessarily so rare after all. There’re as many as 88 equity oriented mutual funds with annualised returns of 13% or more over the last 10 years (returns as of 1 Jul 2016).

13 is not always unlucky

And the implications of a 13% annualised return on the retirement corpus of an individual can be quite significant. At a 13% annualised rate of return on investments, a 30-year old, who wants to retire at 60 with a post-retirement income of today’s equivalent of Rs. 50,000 per month, would need to invest Rs. 15,300 every month in a few high performing equity oriented mutual funds between now and his retirement to achieve his financial goal (this plan assumes a life expectancy of 80). The same Rs. 15,300 every month invested in plain vanilla bank fixed deposits would yield no more than 9% annually and will get the youngster to a post-retirement monthly income of today’s equivalent of just Rs. 22,856! That’s less than half of what the youngster could have drawn post-retirement, had he invested instead in equity oriented mutual funds. And this before considering the impact of taxation. Post tax returns from FDs will be still lower. In contrast, returns from equity oriented mutual funds, as mentioned earlier are completely tax free for investments exceeding 1 year.

Bottom-line

The bottom-line is that if you wish to retire comfortably, there’s no escaping equity oriented mutual funds. Yes, they can be quite volatile at times (unlike the safe and steady returns of bank fixed deposits). But over longer timeframes, returns are far more predictable. More importantly, they’re arguably the only set of instruments available to retail investors whose post tax returns can beat inflation by a significant margin over the long term.

Disclaimer: Mutual funds mentioned in this article should NOT be construed as finpeg’s recommendation to invest in those funds. Actual investments should only be made based on finpeg’s scientific assessment of your age, financial goals and risk appetite, and the investment recommendations made by finpeg subsequent to the same.

 

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Indranil Guha

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