It Is Likely That You Will Not Create Wealth
Thoughts on why SIPs are a great tool to create wealth
Take a look at any of the wealthiest people in the world. They have always focused single mindedly on one thing. That is resilient wealth creation. The normal man, who aspires to be wealthy, however has not understood the key principles of getting there. We give up at the first sign of weakness.
Take a look at the retail investors in Indian markets. The usual playbook is repeating. SIP (Systematic Investment Plan in equity markets) stoppages are at all time highs. People have started enquiring about other asset classes like gold, bonds, and folks have started asking whether they should stop SIPs since markets are falling. This is largely because we haven’t understood how markets work and the tool, i.e. SIP, works.
The problem starts and ends at greed and fear. We get greedy in a bull market and bet the house on stories crafted to fool us and get extremely fearful when markets start correcting.
You may be thinking that there are other ways to get wealthy too. Why is Niraj just talking about getting wealthy through equities? Because equities are the current talk of the town and the subject of today’s letter. I will share my thoughts on other ways of getting wealthy and what’s possible options we have in a future letter.
SIP, also known as dollar cost averaging in the west is the ideal way for retail investors to create wealth. It is one of the tools in the toolbox of a retail guy, along with asset allocation, that can help in creating wealth. The history, in India is comparatively smaller than, say the US, where people have been using the tool diligently. Recently, HDFC Flexicap Fund finished 30 years of existence. Ignore the amounts mentioned in the ad below. Try to understand the power of compounding.
Market timing is required when you have a lumpsum money to invest. Most of us do not have that privilege. So the next best option for us is to invest our monthly surpluses.
For how long though? There are two ways of looking at it. Investing just for meeting financial goals and investing for wealth creation. We will focus on the latter. Wealth creation requires patience. It also requires a key ingredient, capital.
We will assume that there is enough surplus to invest each month and look at some data below to see how long term investing can change the game. (If you think you do not have enough surplus, I would request you to go take a look at your discretionary spends)
These are rolling returns for SIPs continued for different time periods. Can you notice some patterns? Firstly, the longer your time horizons, % times you earn positive returns keep increasing. So, the first rule of SIP should be to continue it for 8 years, at least. Second, take the 15 year rolling returns. You earned more than 8% returns in 99 out of 100 occasions and more than 10% returns in 98 occasions.
Take any calculator and see what happens if you continue investing your SIPs and earn double digit returns from 10% to 15%. You could also use a step-up calculator to assume growth in annual investments with growth in income.
A Slow Start is a Good Start
You may be thinking how to increase the likelihood of earning double digit positive returns over the long run. The best way to do that is start your SIP in a market that is correcting or moving side aways. Look at the chart below. If you earned under 8% returns in the first five years of SIP, then your future returns were in high double digits. This does not mean that you should not start your SIPs in a rising market. I have shared more data on that later.
Where Does The Problem Lie?
Our challenge is not in the ability to continue investing. It’s the understanding of how markets work, and how much risk one can take, and then, being able to stomach the drawdowns. We want to play smart with the markets but the dumbest investor wins. In fact, there was a study done by fidelity that the highest returns were earned by those accounts where the account holders were dead.
Imagine being the unluckiest investor and starting your monthly SIPs in the month of January 2008. Markets corrected by 60% from the peak in Jan’2008. Would you have been able to see the markets slide for the next 14 months and not lose your sleep? Very hard for a person who just entered the markets who just wanted to make some money as well. If you continued your SIP till January 2025, you made 13.5% in returns. If you played smart, and started your SIP in March of 2009, when the markets bottomed, you didn’t do significantly better. You made 13.6% returns. However, the person who started early won because the absolute value of his investments were higher.
Few lessons have been learnt so far -
Market valuations and market timing do not matter for a SIP investor
A falling market is a great time to start investing
The best day to start is today because you will end up with higher absolute amounts
You are a lucky investor if markets do not do well in the early years of investing
Your time horizon will decide the kind of returns you earn and the wealth you create
Who Deserves These Returns?
We should also ask ourselves why do we deserve the higher returns and what is the cost of earning those returns? The cost is obviously the volatility and the uncalled drawdowns in the markets.
Compounding is a very powerful idea. So is reverse compounding. You have to pick sides. If you want to win, you need to be patient, create resilience finances through appropriate risk management and asset allocation, and just keep doing the simple stuff.
Remember, great things can be done when one can extend time horizons.
Buffet did not get wealthy because he bought a dying textile company. He got wealthy because he continued compounding for more than 90 years and counting.
The construction of the Bascilica De La Sagrada Familia was started in 1882 and its not yet complete. Despite still being under construction, its probably one of the best man made structures I have seen in my life.
The Yazd temple, in the city of Yazd, south-east of Tehran, houses a 1500 year old zorostrian fire.
We are fixated on the short term game. Active stock picking, using leverage, trying to beat the benchmark, taking advice from friends, are all tools for reverse compounding. The emphasis must be on becoming shock resistant, avoiding ruin, and staying in the game. The upside will take care of itself as economies grow.
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Thanks for reading. Kindly excuse errors, if any.
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(All the SIP data has been sourced from SIP study done by WhiteOak Mutual Fund)
Investing in the Nikkei Index for three decades could not also guarantee wealth creation. Imagine an investor who did an SIP in the Nikkei and waited for three decades earned sub par returns.
Even the S&P had a miserable 10 years sometime back.
In India too there were phases when returns were negative
When you provide examples of a 1500 year fire and a monument under construction from 1880 onwards , the point that is missing , is that we investors do not have such long life spans.