Most of us are familiar with the above equation. PV is what we invest or the Principal, r is the rate of return, n is the period of investment, FV or amount is what we get at the end of the investment period.
In Primary School, it was called the Compound Interest Formula, while for Financial Planners it is the basis of most Financial Plans. Einstein called compound interest as the 8th wonder of the world. But that’s all that most of us understand about this formula.
Let’s see how it works for Mutual Funds.
Many feel that a huge FV or corpus can be obtained by investing a large Principal or PV. While that is true, there’s more to it.
Some of us are obsessed with return- kitna milega-but that again is missing the point. Why?
While PV is in our control, it can’t exponentially increase FV. While r can exponentially increase FV, it is not in our control.
So, what is in our control and also what can increase FV exponentially is only n. It is a conveniently forgotten factor, but it’s not without reason that experts say “Time in the markets is more important than timing the markets”.
Many of us enter the Equity Markets after the meat of the rally is over. Or enter the Bond markets after G-sec yields have fallen from 9% plus to 7%. Why? Because of “rear view mirror” investing- we always invest after we see the asset class demonstrating good returns. We feel we will enter at the RIGHT time and Exit at the RIGHT time. And often, the RIGHT time turns out to be a mistimed! And worse still, we realize this only after we have entered or exited the asset!
There is another problem-while an Equity Fund like Franklin India Bluechip, which has completed 20 years has given over 20% CAGR since inception, most investors would find that their investment in this Fund has yielded less than 10% return. Why? Birla Income Plus, a fund that is over 15 years old has delivered 10% plus CAGR for that entire period. But can some of us vouch for the same? No! Forget India, worldwide it has been found that while the fund returns are wonderful, the investor returns are not even satisfactory. Why?
Most of us don’t invest in the asset class long enough. While we rant about how the flat purchased by our father for 1.25 lakhs 25 years back fetched us 25 lakhs today, we don’t wait it out for the Equity Mutual Funds that we have invested into. The Funds get exited immediately after the lock-in period is over. Or after a Market Crash. Or after a Market rally. Why? Just to book profits or cut losses. And here again, mistiming causes a dent. Many of us would have exited the Stock market in October 2008, when it touched 8000 levels, fearing a loss. And many of those who did not, would have exited in late 2013 or early 2014, when market crossed 20000 levels, fearing that they may not get another opportunity to book profits. This is the reason why our returns are less than scheme returns. Our timing often turns out to be mistiming! Those who exited at 8000, never got a chance to make profits. Those who exited at 20000 levels of the market early this year, again may not get the right opportunity to make bumper profits for some time. But the people who remained invested from Oct 2008 till March 2014 are the ones who are really sitting on huge profits. Get the point?
Which brings us back to the FV=PV(1+r)n formula and the emphasis on “n” can’t be diluted. After all, “Time is the best Healer” and “Kalaya Tasmai Namah”