When it comes to investing, one of the factors that clouds an individual’s decision making skill is one’s own emotional bias. As a means to circumvent this, financial advisers advocate the use of Systematic Investment Plan (SIP). What an SIP does is that it regulates one's investment into mutual funds without the individual taking a conscious move to invest. In short, the investment goes on, on an auto-pilot mode.
But there are times when investors are jolted out of this well-set arrangement. It typically happens when markets are either rallying or correcting sharply. In case of a market rally, greed comes in and investors look to increase their equity allocation, without taking into consideration their total asset allocation strategy. Historical data also points to the fact that investors tend to invest more during the late phase of the bull market when the markets may have already rallied considerably.
On the other hand, if the markets are in a correction mode, investors in a bid to protect their investments from the downfall tend to either discontinue SIPs or redeem their investment, irrespective of whether the financial goal for which the investment was being made is achieved or not.
There are two often heard arguments. First, this is not a good time to invest as the market is in a free-fall and second, the investor always thinks of coming back to the market when the correction is over. In both the cases, what the investor is invariably trying to achieve is to time the market.
It is a well-known and understood fact that timing the market is next to impossible but investors invariably end up taking investing decision based on their intuition rather than financial prudence.
As a result, not only does one loses the opportunity to create long term wealth but may also end up missing one's financial goals. So, mathematically, what’s the cost of delaying one’s SIP just because the market is not trading in a favourable way?
Make the most of it
Recently, Value Research, an independent mutual fund research house, did an analysis taking into consideration Sensex returns since 1980. In the said time there was a plethora of negative incidents which affected the market from time-to-time.
Some of the major ones would be assassination of key political leaders, major financial scandals (Harshad Mehta, Ketan Parekh, Satyam fraud), financial crisis (Dot Com bubble, Subprime crisis), terrorist attacks and war (Iraq War, 9/11 attack, Mumbai 26/11 attack), natural disasters (earthquake, tsunami), commodity crash to name a few.
So, what would have been the return scenario if an investor decided to stay invested through all these years?
Analysis shows that across market phases, Sensex generated a return of at least 10.3 per cent over a three year timeframe, 10.5 per cent in five years and 14.7 per cent over 10 years, irrespective of the time you have entered since 1980. Now if one would have decided to purchase after the market corrected for 10 per cent in the said timeframe, the returns would have been 15.7 per cent in three years, 12.2 per cent in five years and 16.8 per cent in 10-years.
Conversely, if the same purchase was made after the market rallied 10 per cent, the return profile would be 7.9 per cent in three years, 9.7 per cent over five years and 13.2 per cent in 10-years. Please note: All the figures here are in CAGR terms.
The above numbers clearly show that buying during the downtime in market can prove to be beneficial for a long term patient investor. However, investors tend to do the reverse and miss out on the favourable opportunities presented by the market. The lesson to be learnt from these numbers would be: It pays to be a patient investor.
Now, coming to the next point; the chances of making a negative return. For a retail investor, the biggest put-off when reviewing one’s portfolio is looking at negative returns.
Even though it may be temporary in nature, it is the investments that are in negative that tend to capture our collective attention immediately. This is where time spent in the market becomes important.
Data from Sensex shows that if one is ready to stay invested for a decade in the market, the chances of making a negative return is close to zero.
Will the experience be any different for a diversified equity fund? For a diversified equity fund universe too SIPs over a 10-year period yielded negative returns in just 0.3 per cent of the cases. Further, there is a 90 per cent probability of making positive returns if one is invested for four years and above.
Now for those investors, who had initiated investments into a diversified equity fund at the market peak of 2007, 60 per cent of the funds in this category had moved into green at the end of two years and at the end of four years, 99 per cent of the investors would made gains. This clearly shows that even if one ends up investing at a market peak, one need not worry if they are in the market for a long haul.
To sum up, staying invested through the negative times in the stock market is bound to yield positive investment experience over the long run.
Then again, investments are made keeping in view a financial goal; so investors need not clamp down during market corrections or volatile times. Instead, if possible under the guidance of a financial adviser an investor should look forward to such opportunities to increase the quantum of investment during such phases such that one gets to accumulate more units.
The writer is managing director and CEO of ICICI Prudential AMC