Fixed income investing is back in a big technique
Last evening on the drive back home I must have seen some 45 ads of various bank fixed deposit. I was counting, and I must have missed some. concurrently, my inbox was choking with fixed maturity plan (FMP) offers. Yes, fixed income investing is back and with rates of 9%-10% per annum going around, no wonder investors are flocking as bees to honey.
The reasons are not far to seek. The stock market has been volatile — extremely volatile. In a three year period, from a level of around 17200, it has fallen all the way down to 8100, then recovered to flirt with almost 21000 only to tumble back below 18000 points.
Moreover, the prognosis going ahead doesn’t look too good. Greece’s credit rating has been cut four steps below investment grade — consequently there is a real fear of global credit markets drying up. And the problems are not limited only to Greece. Italy is at risk, Japan is under duress and the economic data coming out of the US is not promising at all. Domestically, after petrol prices, diesel, kerosene and LPG prices may also be raised. If this happens, factors of production will become dearer, leading to a further increase in general price level i.e. price rises. No wonder, investors are a flustered lot.
On the other hand, interest rates are rising and a 10% assured rate either through a bank FD or through an FMP is there for the taking. So why discuss the choppy seas of the stock market when the calmer waters of fixed income instruments await you? Why go after the shocks and surprises that lie in the bush when there already is an assured bird in hand. After all, isn’t discretion the better part of valour? Well, let’s see.
And to see what lies in between, do examine the table. Before you get bored with tabulated analysis and turn to some other page, let me assure you that if you stay with it for a few moments, it would really be worth your while. The results are eye opening.
I have considered two funds — HDFC Top 200 and Fidelity Equity to run the numbers along with the Sensex values. Since we are looking at three year returns, we begin on May 21, 2008. Now we have already seen that the PTP return of the Sensex over the past three years has been 1.71% p.a. However, if you disregard the PTP — point to point investment — and instead had invested regularly each month, then guess what would have happened?
Over the last three years, the market return has been only around 2% per annum (1.71% p.a. to be precise). But note that this is a point to point (PTP) return we are talking about. And a PTP return never gives the correct picture.
This is because a PTP return fails to account for what happened in the interim — between the two points of time under consideration. To put it differently, it just measures the difference between the two numbers at two points in time disregarding everything that lies in between.
The return on HDFC Top 200 is an amazing 23.33% p.a. The return on Fidelity Equity is equally amazing at 22.27% p.a.
The table is self explanatory. ¤10,000 is invested every month from May 21, 2008 in each fund at the applicable NAV. At the end of 36 months, the accumulated units are sold — again at the applicable NAV. Voila! The return jumps as the investor participates in the ups and downs all through the three year period. (Due to space constraint, the figures in the table appear at quarterly intervals. However, for actual calculations, monthly figures have been used.)
The key takeaway from the above analysis is that volatility is your friend, don’t be afraid of it. In fact, I can go out on a limb and say that for a true investor, the more the volatility, the better the chances of making money. As long as you invest regularly, volatility works for you instead of against you. When the going is poor, you get more units for the same value, and when the going is good, you get correspondingly lesser units. However, at the end of the day, more often than not, you will come out ahead. So do you like to buy that FMP?
Source: [dnaindia]
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