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Invest small amounts monthly to reap big gains in the long term Image Credit: Seyyed Llata | Senior Designer, Gulf News

Dubai: Contrary to popular myth, veteran investors often remind that there is nothing like ‘good timing’ when it comes to investments, and it's more about what you need from that investment.

In a Systematic Investment Plan or SIP, you can automate your transfers, and be hassle-free about the date in a particular month. So when investing via an SIP, you don't have to time the markets.

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SIPs are a game of averages and people can invest and continue to make reasonable gains even when the markets are highly volatile. Here, in this article, we discuss just that that.

Stock markets are inherently volatile, a global shock event like a pandemic only worsens uncertainty and induces more volatility. Nevertheless, as a stock index never moves in a straight line, investors need to be ready for volatility. In fact, it is the volatility that allows one to pick up more when prices are low.

In SIP, you invest every month on a fixed date. Every time your SIP amount is deducted, more ‘units’ or parts of a fund get alotted based on your SIP amount and the net value of assets (NAV) on the date of investment. The NAV varies from time to time.

You, as an investor, must always look at the long-term performance across market cycles to see the complete picture of returns for a linked fund or mutual fund. Therefore, in SIPs, as investors need not worry about the right time to enter the market with cost averaging allowing a customer to opt out of this stage.

What is cost averaging or the SIP investment logic?
Cost averaging is a technique that entails investing a fixed amount of money in the same fund or stock at regular intervals over a long period of time. If you have a retirement plan, you're already using this strategy.

This simple investment method asks us to invest a fixed sum at regular intervals – generally monthly. The logic behind cost averaging or SIP is that this helps us capture different market levels.

How have SIP allocations behaved in previous crisis?

But from a markets perspective, the important thing to note is that regardless of the path that the virus takes, ultimately it is more of a one-off disruption that the economy will come out of – and so when we take a longer term view – say 3-5 years, analysts don’t expect any lasting damage to the economy or markets from the current events.

So how should existing investors — especially SIP investors that have been regularly allocating to the markets and likely finding themselves deep in losses — approach this environment? It's only fair that such a sudden change in fortune combined with negative media headlines causes people to question their investment decisions.

However, analysts suggest that any sudden or knee jerk reaction at this time should be avoided and instead investors should take a step back to see how things may play out going forward to help them take a considered call. And to help us do that let's turn to market history.

Illustration to show how SIPs performed in a crisis in India

According to a recent study of the Indian stocks markets conducted over the last 20 years - i.e. 2000 to 2020 to see how SIP investors have fared in normal environments and how that experience changes after a sharp market sell-off, and the study assumed investments into India’s Nifty 50 index.

After computing daily returns of 3 years, 5 years and 7 year monthly SIPS over the 20-year period, the analysts then identified SIP returns for the same tenors immediately after a 25 per cent fall in the markets.

Average returns in the markets have broadly been in the 13-17 per cent range. However, what needs to be noted is the uncertainty around the averages that can come in the markets due to sharp up and dorms. The minimum return during this time could have been negative - that is losses - for the SIPs. However interestingly as the SIP tenures get longer the losses have become lesser till for the 7-year tenure the minimum returns are also positive.

What new or existing SIP investors do in a crisis

After a sell-off however things become really interesting in the study. What we see is that investors who start SIP from these levels see dramatically better average returns compared to the investors in the earlier scenario. And that improvement is sustained over very long periods as well.

While the above analysis is for new SIPS, existing investors can also benefit from these trends through three important steps:

• Let the existing SIPs continue: Essentially any incremental instalment from an existing SIP will work exactly similar to a new SIP and hence get the same benefits.

• Do not redeem accumulated units from previous instalments: Market prices change daily. The only price that impacts investors is their entry and exit price. Focus on the long term potential of the markets.

• Consider topping up or creating new SIPs: If cash-flows permit, sell-offs provide a fantastic time to take advantage of lower market valuations. Unfortunately, stock markets are volatile and there are a number of periods when markets fall by 25 per cent or more, which is a quarter of its value lost in just a few months. At the same time, market corrections have tended to be short and sharp and ultimately the markets have bounced back — to the benefit of investors that did not panic and remained true to their investment objectives.

Conclusion or key takeaway

So what analysts are seeing in the stock markets in terms of the sell-off is not something new (even if the reason for the fall has changed) and investors should not allow these events to sabotage their long term investment journey.

While analysts are confident that the markets will normalise over the medium to long term, they reiterate that SIPs provide the perfect way of investing in such tough market environments because even if the uncertainty lasts a few more months, the regular allocations can help investors average out their entry.

FAQ#1: Course of action if you’re income is lesser now and your portfolio is amassing losses?

Those in distress can consider reducing ticket sizes (the monthly instalment amount) or the option to 'pause'. To build a corpus for contingencies, experts advise to make fresh investments in debt funds.

If you are looking to build liquid cash reserves in a tightened income setting, one expert advice is for wary investors to move their SIPS from the equity to the debt category.

Since investors may be looking to protect the capital and maintain liquidity, they can move their systematic investment plans from equities to debt funds. As the idea is to build contingency provisions, the best suited would be short-term funds and low-duration funds.

Within that, rather than tracking past performance, investors should go for schemes that have the highest exposure to rated funds, and have a lower expense ratio. Other than stopping their incremental SIP inflows, investors can consider these two other options.

If they are concerned about their cash flows for the next two to three months, they can either go for a three-month pause option with their mutual funds, where the money won't be debited from their account for three months — or, they may go for the option of reducing the ticket size of the SIP.

So, one can reduce the SIP monthly instalment by half or a lower sustainable amount. While this will reduce the monthly outgo, it will also ensure that you continue to derive some benefit from lower net asset values on account of the fall in markets.

However as markets are gaining now and rebounding stronger than before, if you’re in a position to continue your investments, this is recommended.

FAQ#2: What should the less impacted ones do, in terms of any changes to their portfolio?

Individuals who are not too constrained on the income front, and who have seen their disposable incomes rise on account of the fall in monthly expenses, may not only continue with their existing equity SIPs, but may even look to direct their additional savings into stocks.

An investment in current times may mean a higher accumulation of units on account of the drop in net asset value of the fund’s units - and so, a rise in markets, as is happening currently, would bring significant gains for investors.