I met Ramesh, my good friend, over for a cup of tea one evening. He had invested in equity markets through the SIP mode. He did this with the intention that his disciplined way of investing will help him earn a solid return and help him achieve his goal of early retirement. But somewhere down the line, all the news of markets rising to all-time highs made him confused. Should he stop his SIPs? Should he withdraw his investment from equity markets completely? Ramesh is not alone. A lot of investors face this dilemma. This article explores it further and provides guidance on what investors should be doing in such situations.
Meaning of SIP and how does it work?
Before you invest via SIP mode, it is essential to get the concept of SIP very clear. A lot of advisors and product agents spread the misconception that SIP mode will give you better returns. That is incorrect. SIP is basically a convenient way of investing your savings regularly in the markets. It also helps you not fall into the trap of timing your investment. A SIP is no guarantee of good returns or that you will not incur losses in your equity investments.
SIP is a very convenient way for someone who wants to put his investment plan on auto-pilot. You take out a fixed amount in the form of savings from your bank account and invest in a mutual fund scheme. This approach helps you kickstart your savings and investment plan and help you better plan your monthly budget. Let us remind you one more time: SIP has nothing to do with returns.
Can you time the markets?
Both scenarios – Investing at a particular market level, even refraining from investing at that level, mean that you are trying to time the market. This is an immature way of investing. Why? Because it is tough to predict the market peaks and lows even for seasoned and sophisticated investors who have all the right forecasting tools.
History has shown that whenever people thought markets were at a peak, it has gone up to higher and higher levels. We cannot predict the future looking back. Still, essentially, when you invest in equity, you are betting on the economy’s long-term future. Markets will correct and then resume their upward journey, and that is how markets work. Our essential task as investors is to ignore the noise and stick to our monthly investment plan. SIP helps us do just that.
What happens when you stop your SIP?
Stopping the SIP when markets go up or down can have a temporary to permanent damaging effect on your investment portfolio and the probability of achieving your financial goal. Basically, you end up stopping new investments towards your financial goal. You may be tempted to invest that money in low-performing avenues like fixed deposits, or worse, end up splurging your money on unnecessary things.
The most challenging thing in this approach is that you don’t know how long this peak will last. Like our stock markets have witnessed, the peak can last for a few years. So, will you keep your investment plan suspended for such a long time? Also, as we saw during COVID, the markets may correct and then rebound very sharply. So, as an ordinary investor, you basically make your life really difficult if you try to align your SIP with the movement in markets.
The Power of Asset Allocation
Asset allocation is an effective risk management tool for any young investor. You can treat the highs and lows of the markets as an opportunity. How? When markets reach a new high, you can rebalance your portfolio and align it with the ideal asset allocation. This will have the effect of booking gains from equity and transferring it into fixed-income investments. By doing this, you reduce the risk in your portfolio.
Conversely, when markets tank, rebalancing helps you enter equity markets at lower levels and thereby reduce the overall purchase cost of your portfolio. This will translate into higher returns in the long term. Please note that rebalancing should be done only at a pre-defined frequency (e.g., annually or half-yearly). Or when the equity markets move too quickly in any direction (say 10-15% in a month). The essential point here is to have a process that you can follow regardless of the market conditions.
What should Ramesh do with his SIP investments in peaking markets?
I explained to Ramesh that market movements should be a non-event for your investment planning. Today we have so much media noise, more than ever. The more you read and listen about the markets and track their movement and listen to the so-called investing gurus on TV, the more you are likely to get confused. Remember – “Time in the market is more important than timing the market”. Be clear on the goal you are saving for, the time frame you need to invest, and just keep investing regardless of the short-term market movements. What you can do is to follow a defined asset allocation. During extreme market movements, you can look at your asset allocation and rebalance the portfolio to align with your ideal asset allocation. Thankfully, by the end of our discussion, Ramesh was relieved and better focussed on continuing his SIP investments in all kinds of market situations.
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