Equity markets had already priced in the decisive election victory of the Modi government right after the exit polls. A stable government with absolute majority augers well for the equity markets as policy decisions become more predictable. However, stagnant corporate earnings, high valuations and worsening global can pose short-to-medium threats to the current bull run. Hence, retail investors in equity mutual fund should invest through the SIP mode to make most of the upside potential while managing the downside risk.
Here is why SIP remains the best model for retail investors to generate long-term wealth.
Does away with market timing
While it is always preferable to invest when prices are low, timing the markets is not easy for most retail investors. To time your investments correctly, you need to have a good understanding of macro-economics, geo-political implications on domestic markets, market valuations and the impact of monetary and government policies on capital markets. Lack of understanding of these subjects along with lack of expertise on judging market movements may lead you to over invest during market highs and underinvest during market lows. Moreover, markets often undergo corrections when they are least expected. Otherwise, they continue with high valuations for a stretched period. After all, volatility is an inherent feature of equity markets.
The problem of timing the investment can be solved by using the SIP mode to invest in equity funds. Through this mode, a fixed amount is deducted from your bank account on a pre-determined date to buy units at the NAV of that particular date. This ensures consistent investment irrespective of market highs and lows, thereby taking out the ‘timing factor’ from your investment decision-making.
Allows averaging of your investments
As the SIP mode ensures investment of a fixed amount in mutual funds every month, equal investments are made at different periods in a year capturing both highs and lows of the market. So, if the market goes through a steep correction in next few months, the cost of units purchased during that correction would be much lower than its present cost. The average cost of your units will go down while buying more units for the same amount of investment. Thus, the SIP mode will turn an adversity (market downturn) to an opportunity (higher number of units at lower cost).
Keeps your emotions in check
Both greed and fear play a major role while making investment decisions, especially when the products are market-linked. While greed entices most mutual fund investors to increase investments during bull market, the fear of further losses during bearish market conditions forces many to stop fresh investments or worse, sell their existing mutual fund investments. As a result, such investors often end up investing too much during the overvalued market and book losses at lows. With SIPs ensuring regular investments of a fixed amount at periodical intervals, it minimizes the influence of emotions during investments.
Things to keep in mind while investing through the SIP mode
Avoid sectoral/thematic funds: Sectoral funds have to invest at least 80% of their corpus in a particular sector, like power, infrastructure, banking, technology etc.; as mandated by its stated investment objective. Thematic funds are those that are mandated to invest at least 80% of their corpus in various sectors related to a common theme, such as energy, consumption, services, etc. As these funds have to mandatorily invest 80% in the mandated sectors and themes, their fund managers move out of them even if they are sure about their underperformance in the foreseeable future. On the contrary, diversified equity schemes are free to increase, decrease or exit sectors or themes according to the changing market conditions.
Thematic and sector funds are usually invested in cyclical businesses, which makes timing of your investment and constant tracking very crucial. Their cyclical nature also makes them unsuitable for long-term investment. Thus, invest in sectoral and thematic funds only if you have the expertise to understand the fundamentals of their underlying sectors/themes and identify their future potential as well as the risks arising from policy decisions, macro-economic conditions, etc.
Opt for direct plans: Direct plan of a mutual fund scheme has lower expense ratio than regular plan. This ratio states the proportion of fund’s average daily net assets for meeting its various operating expenses, such as fund management expenses, distributor’s commission, advertising commission, etc. As direct plans do not incur distribution cost, their operating expenses would be lower than regular counterparts. Lower expense ratio generates higher returns for direct plans as their savings in distribution expenses remain invested, which in itself starts generating returns over time. While their difference in returns might seem negligible during the initial years, it grows into a substantial one over the long term due to the benefit of power of compounding.
Review your investments at periodical intervals: Periodical review of your funds’ performance is as important as regular and disciplined investments. Even star mutual fund performers of yesteryears have been witnessed to remain as hopeless laggards for a long time. Thus, ensure to compare the returns generated by your mutual funds with those of peer funds and benchmark indices at least once in a year. Redeem them for better performing funds if they have consistently underperformed their benchmark indices and peer funds for more than 4 consecutive quarters.
(The author is CEO & Co-founder, Paisabazaar.com)