One should not try to time the markets by stopping and starting a Systematic Investment Plan
Discipline is the bridge between goals and accomplishment and it teaches us to be simple and systematic. For what is supposed to be a simple idea, there are way too many misconceptions about the SIP (Systematic Investment Plan) way of equity investing. SIPs remain misunderstood and misused. Here’s a typical one, ‘The markets are said to be very volatile currently. Is it wise to hold SIPs in such period? In general, those who have a punter’s approach to investing carry over that approach to SIPs, trying to stop and start SIPs by timing the markets. Back in 2010, I recall a few investors claiming that SIPs were no good and that they had barely broken over the preceding years. Generally, these were people who had stopped their SIPs after the crash of 2008 and then restarted after the recovery in 2009. The basic idea behind SIP is that while the general direction of an equity investment is upwards, it is not possible to reliably predict the actual fluctuations that it may undergo as part of its general trend. Instead of trying to time one’s investments, one should regularly invest a constant amount. As time goes by and the investment’s NAV or market price fluctuates, this will automatically ensure that when the price was low, you ended up purchasing a larger number of units. Eventually, when you want to redeem your investment, all the units are worth the same price. However, because your SIP meant that you bought a larger number of units whenever the price was low, your returns are higher than they would have been otherwise. That’s the way it should work. However, you have to allow it to work by going on investing when the market is low and not try to time it. At one level, SIPs are nothing more than a psychological trick to make you invest when the market is low without having to guess what it will do next.
We know that SIPs are the best way of investing in mutual funds and are basically a way of exploiting volatility to increase returns However, the benefits come as much from psychology as from maths. Here, the maths is quite simple. You invest a fixed amount every month in a mutual fund. Automatically, this implements the holy grail of investing–buy low, sell high. Here’s how. Let’s say you are investing INR 20K every month. When the NAV is INR 20, you will get 1000 units, because 20000/20 = 1000. However, if the market dips and the NAV drops to INR 16, you will get allotted 1250 units, as 20000/16 = 1250. This is the key. You have automatically purchased more units when the markets are lower. Thus, SIP means investing a fixed sum regularly, generally at a frequency of once a month. Since the investment happens regardless of the NAV or market level, investors automatically buy more units when the markets are low. This results in a lower average price, which translates to higher returns. When you want to redeem your investment in the mutual fund, all the units you own are worth the same. However, your profit margin is higher for units that were bought at a lower price. Effectively, you have paid a lower average price, which translates to higher returns. That automatically enforces the investor’s goal of ‘Buy Low, Sell High’. And there’s this bit about the psychology? The biggest problem in investing is not in where to invest. Instead, it is whether to invest at all and keep investing through thick and thin. People invest sporadically and then stop investing when equity markets fall. This comes naturally to most investors, generally because falling equity prices are presented as a crisis in the mass media. Of course, this makes no sense. As a buyer of anything, you want low prices. So should you as a buyer of equity or equity mutual funds. But for the most part, investors do not.
As a matter of fact, SIPs neatly solve these two problems that prevent investors from getting the best possible returns for their money. They are actually the best feature in mutual fund investing and yet are not actual funds themselves. SIPs are the schedule on which you invest. However, while this maths is great, it’s not the main reason why people get great returns out of SIP investing. The reason for the returns is in the psychology of investing. SIPs are the simplest way of investing regularly and getting good returns from equity, without having to worry about when to invest and when not to invest and thus often missing out on the best opportunities. When the markets turn discouraging, the general instinct of many investors is to stop investing, either because they are scared or because they are trying to catch the bottom. However, SIP investors – not all but most – tend to continue their SIPs. Soon, when the markets go up, this teaches them the value of not stopping their SIPs in bad markets. Thus begins a virtuous cycle, creating a larger new generation of investors who understand the value of regular investing. Over the last five odd years, an additional development in the actual mode of paying for the SIP investment has improved matters further. Earlier, SIPs meant writing a pile of cheques and giving them to the fund. Obviously, there was a limit to this, generally anything from 12 to 36 months. As a result, investors felt that an SIP was a fixed tenure plan. When the cheques would run out, investors would take their time to go through the whole effort again. At that point, if the markets were looking depressed, they would not do it at all.
In current day scenario, investors generally give an ECS mandate for the monthly SIP investment amount to be directly transferred from their bank accounts. Generally, this is a perpetual mandate. Stopping the SIP requires an instruction to be registered. Earlier, stopping was automatic but continuing involved a fresh pile of cheques to be written. In my experience with investors, I have felt that this change of defaults has had a huge impact. The kind of returns that one can get with SIPs are truly mind-boggling. Here’s a simple analysis of four funds that have been around for decades. Its calculated by what would have happened if one had done a modest SIP for the last twenty years. It turns out that just a small investment of INR 5K a month over two decades left me with sums of between INR 1.29 to INR 2.05 cr for these four funds. The amount invested in each case was just INR 12 lakh (INR 5K a month for 20 years). An investment like this can change the life of a middle-class person. However, there’s no special complexity in doing this. Just something straight forward, done over a long period by just following a disciplined approach.
The simple point I want to make here is that “one should not try to time the markets by stopping and starting SIPs” as it is a very simple idea and if you complicate it, you will actually get worse returns. There will be noises in the mass media but we need to put our headphones on, to cancel the noise and hear the music to succeed at long term investing.
(Ifthikar Bashir is a freelance Financial Advisor)