Mutual funds offer the best way for retail investors to participate and benefit from the uptrends in capital markets
SIPs are a regular investment plan available on all kinds of mutual fund schemes, though they are the most effective in equity schemes, as equity is a more volatile asset class than debt.
Those mutual fund schemes which have predominantly higher allocation to equities are suited for long-term goals while those with higher allocation to debt are suited for short-to-medium term goals. The potential of equities to generate a higher real rate of return than other assets is more over a long term. Hence, investors who have to achieve goals which are at least 10 years away may consider investing through equity mutual funds.
On the journey towards goal-based investing, the volatility associated with the equity as an asset class needs to be taken in stride. The NAV of equity mutual funds may witness dip over the short-to-medium term but instead of redeeming the investments, staying invested to reap benefits over the long term remains a better alternative. Rather than trying to time the market, it is important that one follows the approach of ‘time-in-the market’.
There is a better way to avoid timing the market and yet keep the average purchase price low. It is achievable by following the mode of systematic investment plans (SIPs) while investing in equity mutual funds. SIPs are a regular investment plan available on all kinds of mutual fund schemes, though they are the most effective in equity schemes, as equity is a more volatile asset class than debt. SIPs help you profit from volatility by automatically buying you more units when prices are falling and fewer units when prices are rising, thus lowering your average purchase price, while inculcating some much needed discipline into your investing habits.
Usually, you invest in a scheme at its prevailing net asset value (NAV). Under SIPs, however, your investment in the scheme is staggered. Instead of a lump sum, you invest a pre-specified amount in a scheme at pre-specified intervals (monthly or quarterly). The number of units you get on each investment is based on the scheme’s then-prevailing NAV.
Rupee cost averaging SIPs are based on the principle of ‘rupee cost averaging’— an investment strategy common in the stock market. An SIP enables you to use a fall in your scheme’s NAV to your advantage. When its NAV falls because of a fall in the market, you will accumulate more units at lower rates. Further, an SIP restrains you from going overboard in a rising market, by giving you fewer units at those higher levels.
Over long periods of time, at least a market cycle, this disciplined approach to investing tends to bring down your average unit price. At most times, your average unit cost will always be below your average sale price per unit, irrespective of whether the market is rising or falling. Mutual funds offer an excellent avenue for retail investors to participate and benefit from the uptrends in capital markets.
In order to reap maximum benefit from mutual fund investments, it is important to diversify across different categories of funds. While anyone can invest in the securities market on their own, a mutual fund is a better choice for the only reason that all benefits come in a package. No matter how the market performs over the short-to-medium term, if your objective is to save for long-term goals, linking your SIPs to your long-term goals is the right step forward.
The writer is chief marketing officer, Bajaj Capital