There are 2 ways to beat market volatility.
The first requires being able to time your entry and exit into and out of the market with accuracy. If you can correctly predict market movements, you will be able to sell at the top and buy at the bottom every time. But, unfortunately, it’s not easy to get this right, and attempting this is what turns good long term investors into risky traders.
During the market crash 4 years ago, a large number of investors redeemed their investments, expecting markets to free-fall. Now that we have the benefit of 20:20 vision in hindsight, we can say with certainty that redeeming at that time was a bad move. When markets fall, what is happening is investors are receiving an opportunity to take the first step of the golden investing rule - i.e. to buy low.
However, it is easy to understand the panic that can set in when portfolio start losing value the way they did during the onset of this financial crisis. One way to therefore sidestep the messy emotion that comes with watching your portfolio lose value, is to invest via the Systematic Investment Plan (SIP) mode.
If you are investing in equity (whether mutual funds or direct equity) it can be difficult to figure out when a stock price or a mutual fund NAV (the weighted average of multiple stock prices) is low enough for it to be an attractive entry point. Add to that the fact that market volatility often can make investors freeze, not knowing whether to buy or to sell.
This is where a SIP comes in handy.
In a SIP, you invest a pre-determined sum into a particular mutual fund on a pre-determined date. This mode of investing offers a number of advantages, let’s see what they are:
- Opportunity for retail investors
This mode of investing allows you to take advantage of the growth potential of equity mutual funds by investing a small amount of money each month, thereby providing an opportunity to those investors who don’t have access to large sums of investible surplus at one time. A SIP can be started with as little as Rs. 500 a month.
- Regular Savings Habit
Perhaps one of the best benefits of a SIP is that it encourages you to invest regularly, which in turn encourages you to save regularly. Too many clients come to us in their early 30s saying that they don’t really save much money, and they’re not sure where their funds are going. Starting a SIP, particularly one in the beginning of the month, acts as enforced savings and investment. Before the money can be spent, it has been invested.
- Rupee Cost Averaging
SIPs work best in a falling market - they ensure that you buy when the markets are falling i.e. you Buy Low. It is only in markets that are continuously falling that an SIP would not be helpful. However over the long term, markets rise. That's when your SIPs would reap profits. While investing systematically in mutual funds, if you choose about 3 - 5 funds depending on your asset allocation and risk appetite, you can choose different SIP dates for your investments. This means you are investing on 3 or 5 different market days per month, instead on 1. So with 5 different schemes you can invest on 60 days in a year. This would help you average your costs over 60 market days instead of 12 market days.
These are the main benefits of SIP investing.
Let’s go on to a brief example to illustrate how a SIP can help you build wealth and achieve your life goals:
Suppose, upon assessment of your cash flows, you decide to invest Rs. 15,000 a month in a portfolio of equity mutual funds. Assuming you invest for 60 months (5 years), and assuming an annual growth rate of 12%, your investments will yield a future value of Rs. 12.25 lakhs at the end of the 5 year period.
Now imagine, ceteris paribus, you invest Rs. 20,000 per month instead of Rs. 15,000 per month.
Your future value comes to Rs. 16.33 lakhs in 5 years. So just remember that even a small increase can make a big difference in the wealth you build to achieve your life goals.
When investing in equity, there are some things to keep in mind:
- A classic mistake that almost every investor makes is to invest without any definite time horizon.
The standard thinking is ‘I will invest as long as I can, until I need the money, at which time I can just redeem my investments.’
This method can hurt you. The right way of doing things is to establish a time horizon before you invest. This time horizon plays the role of determining where you are going to invest i.e. equity, debt, or gold. Think of it this way. People who invested in 2008 have still not seen their capital recover, and it has been 4 years. You need a minimum 3 to 5 year horizon before investing in equity. Figure out when you’re going to need the money, and for what, and then invest accordingly.
- Always keep taxation in mind
If you’re going to be investing in equity, know the tax rules. Equity is taxed at 15% in the short term (redeemed within 365 days). Another reason to stay away from equity if your time horizon is a short one. also keep this in mind when redeeming your SIPs. Some of them might have been invested less than 12 months ago, so if there is a gain on these investments, it will be taxed.
- Choose Your Schemes Wisely
We still see investors on the lookout for the next hot scheme. Sectoral and thematic schemes have stayed out of our recommendations for a reason - they are too risky, and not diversified enough. Stick with well diversified equity mutual funds that have a proven track record (at least 3 to 5 years historical performance, even though it is no guarantee of future performance it still helps give you an idea of how the scheme has performed).