Today I am sharing some questions that I have answered recently. I hope they are helpful to you as well.
Q: On tracking error, is it even a relevant parameter that should be considered while making a decision regarding which fund to invest? Is their a data source which captures the tracking error across various index funds?
A:Since the purpose of an index fund is to track the index and deliver the closest possible return, tracking error is a relevant parameter to understand the consistency / volatility of the fund’s return relative to its underlying index.
Mathematically, you find out the standard deviation of the difference in the returns of the fund and the index and get the tracking error. Lower the error, the better.
AMFI has a resource to see all tracking error data in one place.
Q: What is the difference between XIRR and IRR? What to use when?
A: The IRR in both the terms stands for Internal Rate of Return, a way of measuring the return based on cash flows from a project or investment. The IRR is used typically for an investment or project that has consistent inflows/outflows – regular periodicity.
XIRR is more useful when there is variability in when cash flows happen. Check out this link for making friends with XIRR.
When you use IRR in excel, it will assume equal gap in time between cash flows. In case of XIRR, the date on which the cash flow happens is also considered.
Q: Please check account statement (as on July 31, 2022) of Arbitrage Fund. Why is the return less than FD?
A: The current absolute return (for 3 months) for the fund is 0.78% approx. I don’t recall FD rates at the time of investing.
As of July 28, 2022 – interest rate offered by Axis Bank is 3% for 3 months and 3.5% for 3 to 4 months tenure. or about 0.25% to 0.3% on a monthly basis.
For 1 year and 5 days, the offered rate is 5.45%.
Even if we lock in an FD for 1 year now at the current rate and pay 25% tax (corporate rate), the net is 4.08%.
The arbitrage return is expected to be, say, only 5% in the next year. With 10% long term capital gain tax, the net is 4.5%.
if less than 1 year, then 15% STCG and net is 4.25%.
Arbitrage is purely a net of tax play over other debt funds and FDs.
Q: Is it still a good time to invest money in equity or should I wait?
A: That is one of the most difficult questions to answer. We will have to use both the left and right brain to address this.
If you look at our asset allocation indicator, it states that one should stick to the asset allocation and may be go slow on adding new money (specially if there is a lumpsum involved).
With that in perspective, you can spread out your lumpsum investment over the next few months.
Will that lead to higher returns? No one knows.
Will it give you peace of mind? I think it will. Losing money (even temporarily) is far more painful than the pleasure of making profits.
That's all for today. Thank you for reading.