Mutual Funds Strategy 109: The Curious Case of Asymmetric Returns
You might have seen countless calculators used by financial advisors. They say that if you invest Rs10000 monthly, your total fund value will be 25 lakhs in 10 years.
The statement is not wrong per se, because a computer program gives the final result. Most likely the advisor would have assumed a 13% constant return per year for the 10-year period.
You might already be aware there are 3 types of mutual funds
- Equity
- Debt
- Hybrid
https://viswaram.com/mutual-funds-day-19-multicap-fund-3c820cdd5524
Equity funds cannot promise you fixed returns in a period, that is because no one can predict with accuracy what will the capital appreciation or dividend payout.
Whereas Debt funds, also called fixed-income funds can forecast the returns yield with a higher confidence level because the money is lent. Just like a loan, the terms of the interest payout are fixed (unless restructured) and the lender knows in advance what will be his interest income.
The mutual fund calculators you see online and with most financial advisors are designed with the “fixed income” model, i.e. getting a pre-defined interest income per year. There is a 99.99% probability that this would not work for an equity mutual fund.
What if the 10 year returns of a mutual fund were 5.5%, 8%, -2.5%, 24%, 16.3%, -2.1%, 15%, 18%, -1.5%, 16.1% — how do you estimate your final fund value?
This would be the right time to introduce an in house calculator that I have made on a spreadsheet. If you provide the required inputs, you can see the final fund values and the performances. These calculations will work for forecasts or even historical data.
You can take a look at my online spreadsheet at https://docs.google.com/spreadsheets/d/1PJO_ou5jxjNHmhKeUAFVM7cn17JIKFe5czRE4K-kGUc/edit?usp=sharing
You will see a provision to input your original capital (green box) and then yellow highlighted columns where you enter the annual returns. The final fund value will automatically appear on the last column against the year you are comparing with.
You can find the provision to calculate the final fund value for these 3 periods
- 10 years
- 15 years
- 20 years
If you wish to calculate the value for 5 years, just input the annual returns to any of the above periods and consider the value till “Year 5 Fund value”.
You know that people invest in mutual funds based on a pre-defined goal. While they set the goal, they might have estimated the fund value after 10 years.
What if they have already completed 6 years and now need to re-estimate the performances required for the next 4 years? This is where my calculator fits in, all they have to do is enter the actual value (realized) for the first 6 years and then play around with the combinations of “returns expectation” for the next 4 years.
If you input the actual results of your first 6 years of performance and try out the forecasts for the next 4 years — you will get an upper hand in the decision-making process.
If the “returns expectations” are higher, eg: current average = 12.5, required rate = 18% — then you might have to switch to a higher risk, higher returns asset class to meet your goal.
If the “returns expectations” are lower, eg: current average = 16.5, required rate = 8.5% you could even tone down and move to a safer fund thereby preserving capital.
I request you to try out the different possibilities and combinations, in case you require help — you can reach out to me @viswaram
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Calculators are for illustrations only and do not represent actual returns.
Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.
https://viswaram.com/mutual-funds-day-19-multicap-fund-3c820cdd5524https://viswaram.com/mutual-funds-day-19-multicap-fund-3c820cdd5524