Understanding the nature of stock market returns

Sensex Total Returns Index: 1979 to 2013

Negative returns: 4 periods out of 32Lowest return: -11%Highest return: 50%

Negative returns: 2 periods out of 30Lowest return: -2%Highest return: 45%

Negative returns: 1 periods out of 28Lowest return: -2%Highest return: 36%

Negative returns: 0 periods out of 25Lowest return: 3%Highest return: 30%

Negative returns: 0 periods out of 20Lowest return: 8%Highest return: 26%

Negative returns: 0 periods out of 15Lowest return: 12%Highest return: 21%

Negative returns: 0 periods out of 10Lowest return: 15%Highest return: 20%

Sensex Total Returns Index: 1979 to 2013

5%

S&P 500 Total Returns Index: 1871 to 2013

Source: http://www.moneychimp.com/features/market_cagr.htm

12%

Sensex Total Returns Index: 1979 to 2013

S&P 500 Total Returns Index: 1871 to 2013

Normal Distribution

Source: http://www.mathsisfun.com/data/standard-normal-distribution.html

Mutual Fund Star Ratings

Source: MorningStar.com

68% of values are withinone standard deviation of the

mean

Higher risk does not imply higher return!

Return

RiskStandard Deviation

Higher risk does not imply higher return!

Return

RiskStandard Deviation

Return

Increasing Risk (Standard deviation %)

3Y-return/Risk

Sensex 1979 to 201315 year CAGR

Transformed Distribution: Square Root

14% +/- 4%

Return expectation

• Equity allocation60%

• Debt allocation 40%

• Equity expectation 10% (after tax)

• Debt expectation 6-7% (after tax)

• Portfolio expectation

10%(60%) + 7%(40%) = 8.8% (approx.)

Investments are assumed to start simultaneously

Years to goalPresent costInflation Post-tax rate of return of portfolio 8.8.00%

Future CostAmt invested so farPost-tax rate of return on current investment

Future value of curr. Inv. Annual increase in monthly invest. %Initial monthly investment required

Annual increase in monthly invest. %Initial monthly investment required

Goal Planner

Asset Allocation

Finding the balance between risk and reward

How much should my equity exposure be?

Should it decrease with age?

Farther the goal, higher the equity exposure?

Portfolio with 50% equity and 50% debt

Asset Allocation

Maximum Loss: worst case scenario

Asset Allocation

Time Frame Conservative Moderate Risky Mad-Max

< 5 Years FD/RD ~ 10% Eq 30-40% Eq > 60% Eq

7 Years FD/RD 10-20% Eq 40-50% Eq >60% Eq

10 years FD/RD 40% Eq >60% Eq 100% Eq

10-15 Years <40% Eq 60% Eq 80% EqFD/RD100% Eq

>15 Years < 60% Eq 60% Eq 80% EqFD/RD100% Eq

Time Frame Conservative Moderate Risky Mad-Max

< 5 Years FD/RD ~ 10% Eq 30-40% Eq > 60% Eq

7 Years FD/RD 10-20% Eq 40-50% Eq >60% Eq

10 years FD/RD 40% Eq >60% Eq 100% Eq

10-15 Years <40% Eq 60% Eq 80% EqFD/RD100% Eq

>15 Years < 60% Eq 60% Eq 80% EqFD/RD100% Eq

Essentials of a good portfolio

• Minimalist : We must be able to justify the presence of each asset class or instrument.

• Minimum number of asset classes

• Minimum number of stocks, equity funds or debt products

• This will typically make the folio diversified among and within asset classes

Simple portfolio ideas

Equity (60%) 10% return

1. Single Large Cap fund

2. One large cap +one mid/small cap fund

3. Single Large and mid-cap fund

4. Single equity oriented balanced fund

Debt (40%) 8% return (pre-tax)PPF for 15+ Y goals for options 1,2 & 3 (do not max!)

Ultra-short-term liquid funds for less than 15Y goalsBanking debt mutual funds

Long-term goals (10+ years)

Simple portfolio ideas

Equity (0-40%) 8% return

1. Single Large Cap fund

2. One large cap +one mid/small cap fund

3. Single Large and mid-cap fund

4. Single equity oriented balanced fund

5. Single debt oriented balanced fund

Debt (100-60%) 8% return (pre-tax)Ultra-short-term liquid funds for less than 15Y goalsBanking debt mutual funds

Medium-term goals (5-10 years)

Simple portfolio ideas

Equity (0-10%) expect nothing!

1. Single Large Cap fund

2. One large cap +one mid/small cap fund

3. Single Large and mid-cap fund

4. Single oriented debt balanced fund (5Y)

Debt (100-90%) 6-7% return (pre-tax)FDs, RDsUltra-short-term liquid funds for less than 15Y goalsBanking debt mutual funds

Short-term goals (0-5 years)

How many funds should I hold?

• Minimum:

1 fund! (all goals combined into one)

• Maximum:

No of long-term goals (10Y+) x (1 or 2)

How Important is

Mutual Fund Selection?

Large Cap Funds

Computed with SIP calculator, thefundoo.com

Large Cap & Large/Mid-Cap Funds

Computed with SIP calculator, thefundoo.com

Large Cap, Large/Mid-Cap & Mid/Small-Cap Funds

Computed with SIP calculator, thefundoo.com

Lump sum returns

Minimalist Portfolios

• Single Large Cap mutual fund (60%) + PPF (40% only!)

• Single Equity-oriented balanced mutual fund

• Single Large Cap or Large and Mid-cap fund with exposure to international stocks.

• Equity fof + Debt fund of fund

• Single portfolio fund of fund

How to select an equity mutual fund?

• Decide on the strategy.

(1)Why are you investing?

(2) What kind of portfolio will you be using?

Equity mutual funds: How to select/evaluate

Equity mutual funds: How to select/evaluate

Equity mutual funds: How to select/evaluate

Upside Capture ratio: When the benchmark has given a positive return (> 0), has the fund outperformed it?Higher (> 100%)  the upside capture ratio, the better. 

UPC = 120% => 20% out-performance during up-market

Downside Capture Ratio: When the benchmark recorded a loss, that is a negative return (< 0), did the fund record a lower or higher loss?Lower the downside ratio (<100%), the better. 

DCP = 85% => 15% out-performance during down-market

Equity mutual funds: How to select/evaluate

Rolling returns analysis

3YFund (blue)

Vs benchmark

5Y

Retirement Planning

Corpus ~ 300 times current annual expensesCorpus ~ 38 times annual expenses at retirement

Invest as much as you spend each month for retirement!

Current dateYears to retirement 24Age at the end of current year 40Years in retirement 26Total annual expenses 520000Annual expenses when you retire 44,42,903 Corpus required 14,70,12,786 Corpus accumulated so far (updated from mf holdings) 20,82,664 When you retire the corpus from other sources will grow to 98,46,585 When your retire the current mf corpus will grow to 2,05,13,686 If you were to retire today the current corpus will last for (years) 6.63If you were to retire as intended you will be financially independent for (years) 6.49Net corpus required 11,66,52,514.90 investment required each month 41,118 Provided this investment increases each year at the rate of 10.00%EPF or NPS divided by investment amount 54%

Financial Goal Tracking

• Be obsessed over goal planning entries not over mutual fund corpus

Anatomy of a bull market

Anatomy of a bull market